New norms for mutual fund sector

Sectoral cap on debt funds will help diversify risk, but might reduce returns

The Securities and Exchange Board of India (Sebi) might soon take steps to help the mutual fund sector.

The market regulator will decide next month on the recommendations of the Mutual Fund Advisory Committee to have a sectoral cap for debt mutual fund schemes. If the recommendation is made a norm, debt mutual funds will have to invest only a certain percentage in any given sector (see table for the sectors that debt funds invest in).

At the moment, there is no such sectoral cap. Each fund house decides how much it will invest, in which sector.
 

DEBT FUND INVESTMENT
Industry	% of allocation
Banking	71.49
Brokerages/ Corporates	5.14
Housing finance	3.96
Hire purchase	3.46
Equipment leasing	3.11
Investment services	2.31
Power projects	1.13
Infrastructure/ SME/Agriculture Finance companies	0.9
Telecom services	0.74
Electricity distribution	0.6
As on March 31, 2012                       Source: Value Research

This proposal has come after the market regulator observed several debt funds, especially fixed maturity plans (FMPs), were taking huge exposure in specific sectors, raising worries about systemic risk.

The advisory committee has recommended a cap on debt schemes’ exposure to any sector at 30 per cent. The aim is to reduce exposure of debt schemes to non-banking finance companies (NBFC), as they have the largest exposure, followed by banking and public sector undertakings (PSU).

According to data from Value Research, a mutual fund rating agency, 71 per cent of debt fund allocation was made to the banking sector and NBFCs (as on March 31).

For instance, SBI Dynamic Bond Fund invests 50 per cent of its corpus in non-convertible debentures (NCDs), 43 per cent in certificates of deposit and five per cent in reverse repo/CBLO and a little over one per cent in zero coupon bonds.

The sector that has the lion’s share of the corpus is the banking sector (close to 40 per cent).

A cap will imply that the risk factor of overexposure to any one sector will be reduced considerably. “At the moment, since a majority of the corpus is invested in papers of one sector, the risk gets concentrated. If anything goes wrong with that sector, the chance of you losing money is more,” explains Mahendra Jajoo, executive director and chief investment officer (fixed income) at Pramerica Mutual Fund.

Putting a cap will help in diversification and proper risk distribution, instead of limiting it to just a sector. For instance, if 85 per cent of a fund’s investments are in the real estate industry’s paper, since it is a high return sector, the funds would be dependent on real estate to deliver returns. If there is a sectoral cap, the returns will come from a couple more sectors. Say, the fund will invest 30 per cent in real estate, another 30 per cent in banking, maybe 20 per cent in telecom services and the remaining in power projects. The returns will be spread across these sectors in this ratio and so will be your risk.

Any kind of diversification is good, says Hemant Rustagi, chief executive officer, Wiseinvest Advisors. “The recommended 30 per cent is enough to make sure there is adequate diversification. And, it is not a small number. A cap of, say, 10 per cent would have been a small one,” he says.

According to data from Value Research, at the moment, a major portion of debt mutual funds’ corpus is invested in papers from the banking and NBFC sectors. The rest of the sectors have very little allocation from these schemes. Only five per cent of the total corpus is allocated to brokerages and corporates (JM Financial, Axis Capital Markets and United Breweries). One per cent goes to power companies (Adani Power and JSW Energy) and 0.9 per cent to infrastructure/agriculture finance companies (IFCI, Sidbi and Nabard).

At the same time, with such diversification the returns by these funds could see a marginal dip, says Suresh Sadagopan, a certified financial planner.

But Jajoo has a different opinion. “Returns are a play of market conditions and many other factors. It needn’t affect the returns adversely,” he says.