In debt funds, focus on the quality of the paper

While following some simple rules can keep you safe, it is important to remember that debt funds aren't risk free

Retail investors in debt funds are worried. In the past few weeks, the Securities and Exchange Board of India (Sebi) has expressed discomfort at the large exposure of some fund houses to sectors such as steel, power, and real estate.

Some fund houses have significant exposure to the paper of the recently-downgraded Amtek Auto and Jindal Steel and Power Ltd. In addition, JPMorgan's recent proposal to carve out the troubled portion - Amtek Auto's investments - into separate units, was a first in the Indian mutual fund sector.

While JPMorgan has made its move to tackle the crisis, many say the bigger worry is the paper of steel, power, and realty companies. "We are engaging with investors who are worried about the safety of their schemes. We have been discussing the portfolio with them in detail," said the head of one of the largest mutual fund distribution houses. He added, besides companies, many high net worth (wealthy) individuals and some retail investors also had exposure to debt funds from a short- to medium-term perspective. And, they are a worried lot.

So, what should they do? Nilesh Shah, managing director, Kotak Mutual Fund, says: "Since fund houses disclose their entire portfolios every month, investors should look at them carefully before investing. Investors will find the majority of the paper are sovereign-rated or high-quality paper."

Hemant Rustagi, chief executive, Wiseinvest Advisors, says: "First, one needs to understand the fund. For instance, if some fund is saying it is a credit opportunity fund, the fund manager will clearly take risks to generate returns. So, an investor getting into such a scheme has to be clear about what he wants."

Financial advisors believe most investors put money in debt funds for safety. In such a case, rather than chasing returns, it is better for them to concentrate on the quality of the paper (AAA or AA). If the quality of the paper is suspect, but is giving 50 basis points more, it is better to stay away.

Another important factor to look at is exposure of the scheme to a particular company. According to Sebi guidelines, a scheme can invest as much as 15 per cent in a particular company's paper. However, with the permission of trustees, this could be increased to 20 per cent. In a recent communication to fund houses, the regulator re-emphasised this: "According to norms, the maximum exposure in debt securities of a single issuer is capped at 15 per cent and, in some cases, it can go up to 20 per cent, with the approval of trustees…you might like to reassess the internal exposure limits, both to a single entity and a group," it said.

A financial planner says: "If I have Rs 100 and 20 per cent has to be invested in debt, I will invest only Rs 5 in such credit opportunity funds." In other words, limit your risk to debt schemes, much as in equities.