MF distributors worry as investors singed in debt fund market

Following the turmoil in the debt market, mutual fund (MF) distributors are likely to face tougher questions from wealthy clients who park surplus cash in fixed income products on the assurance of capital protection.

Bond yields across debt securities surged and fund houses faced redemption pressure this week after the central bank announced measures to tighten rupee liquidity to stem its fall against the dollar. The rise in yields resulted in capital losses or wiped out gains made over time by fixed income investors. "This was a shocker, as NAVs (net asset values) fell significantly. Investors who entered these schemes in the past two to three months are already seeing negative returns," said Hemant Rustagi, chief executive of Wiseinvest Advisors.

On Tuesday, the benchmark 10-year bond yield shot up a little over 50 basis points to close above eight per cent after the Reserve Bank took steps to tighten liquidity. Yields on short-term paper, including treasury bills, certificates of deposit and commercial paper -- where MFs predominantly invest -- also rose as high as 200 bps. The rise in yields impacted the NAVs of debt schemes like gilts and liquid funds, which plunged as much as four per cent, translating into negative annualised returns of 800 per cent.

"There will be questions raised by investors regarding the safety of their capital in these products. With uncertainty over the rupee direction, there is no consensus among participants about the market direction," said a fund manager. The losses incurred by these investors has also heightened the debate on the recently-introduced colour-coding of MF products. The markets regulator had asked fund houses to colour-code schemes as blue, yellow or brown, depending on the incremental risk to the capital invested, in that order. "The rise in bond yields impacted the blue-coloured MF schemes the most, a shock to investors," said a debt fund manager with a foreign fund house.