Active Stocks
Tue Apr 16 2024 15:59:30
  1. Tata Steel share price
  2. 160.05 -0.53%
  1. Infosys share price
  2. 1,414.75 -3.65%
  1. NTPC share price
  2. 359.40 -0.54%
  1. State Bank Of India share price
  2. 751.90 -0.65%
  1. HDFC Bank share price
  2. 1,509.40 0.97%
Business News/ Money / Personal-finance/  Fear of credit risk in mutual fund companies: hype or reality?

Fear of credit risk in mutual fund companies: hype or reality?

Last week, rating firms downgraded a few companies from IL&FS group, which led to a fall in NAVs of some debt mutual funds. Is the fear of credit risk in asset management companies and insurance real?

Credit risk is very much a part of fixed income investment. Photo: iStockPremium
Credit risk is very much a part of fixed income investment. Photo: iStock

Swarup Mohanty, Chief executive officer, Mirae Asset Global Investments (India) Pvt. Ltd

With higher return comes higher risk

Credit risk is one of the main risks associated with debt fund investing. Over the last few years, we have seen its reference going up. This is due to the fact that returns from top-rated securities have been coming down and to generate higher returns, portfolios have started investing in lower-rated papers. While investing, fund managers do their own rating process, which ideally is independent from that of any external rating agencies, to form their own opinion and invest. Note that rating is always an opinion and not any guarantee. The recent IL&FS downgrading should be a great learning for investors—it is a rating downgrade at the moment and not a default. Due to the downgrade, net asset values (NAVs) fell as valuations of the paper changed.

There are two possibilities. On the paper’s maturity, if the issuer pays the money then the value is restored and the NAV would get corrected on that day. In case of a default or delay, the NAVs could be impacted adversely. So one must wait for proper communication before acting.

Investors need to understand that to get that higher return, there is a certain risk that needs to be taken. There are products catering to each risk profile and the key is to understand one’s own risk taking ability and invest accordingly.

Manish Kumar, Chief investment officer, ICICI Prudential Life Insurance Co. Ltd

Strict rules in place in insurance sector

For life insurance companies, the outperformance of funds over the benchmark is predominantly driven by interest rate calls rather than credit calls. Existing regulations by the Insurance Regulatory and Development Authority of India (Irdai) are risk-averse and this has helped the life insurance industry navigate difficult periods in the market, especially the 2008 crisis. As per Irdai regulations, insurers need to invest at least 75% of their fixed income portfolio in AAA or equivalent rated securities.

Regulations for life and pension funds are more stringent. All life insurers have internally adopted a more conservative approach than what is prescribed by Irdai. On an average, life insurance companies have 80-90% of their portfolio invested in AAA or equivalent rated securities in their traditional and unit-linked portfolios.

Irdai also mandates that any bond that is rated below AA (AA and below) needs approval from its board members and the limits available for investing in such bonds is more stringent. Irdai has also put in place limits to reduce concentration risk. These regulations mitigate credit risk to a great extent.

Nilesh Shah, Managing director, Kotak Mahindra Asset Management Co. Ltd

Mutual fund houses manage risk well

Credit risk is very much a part of fixed income investment. There are no free lunches in the market. There is no return without taking risk. As professional fund managers, we are supposed to optimise return by managing risk.

If we look at other peers like banks or non-banking financial companies (NBFCs), mutual funds’ track record in managing credit risk has been significantly superior.

Most of that has happened as mutual funds have invested at the higher end of the credit curve. Fund houses have also managed risk well as they have structured the investment tightly and are happy to enforce security when required.

Fund houses manage funds from zero credit risk like government securities (G-secs) funds to higher credit risk like credit opportunity funds.

There will always be an element of risk in generating debt returns. Investors must evaluate a debt fund performance based on the risk taken. The risk will be credit risk, liquidity risk and interest rate risk. Any fund manager will strive to optimise the return per unit of risk taken.

Joydeep Sen, Founder,

The risk cannot be seen in isolation

To put in context, the credit risk apprehensions in mutual funds should not be looked at in isolation after a couple of incidents; there should be a holistic perspective. The perspectives are (a) credit risk funds, with at least 65% in high-investment-grade but less-than-highest rated instruments are of a different credit profile than funds investing in AAA-rated instruments (b) the historical default rate, as per a study by Crisil on 10-year data, is 0.2% for AA-rated instruments and 1.9% for A-rated instruments (c) the NPA levels in credit risk fund category of mutual funds is near-zero, against the data mentioned in point ‘b’ and significantly lower than the double-digit NPA (non-performing assets) levels of the banking industry and (d) credit ratio is positive i.e. in FY2018, Crisil executed 1,402 upgrades against 839 downgrades. 

AMCs have due diligence and tracking process in place, but incidents like the ones in the recent past cannot be ruled out. The credit spread i.e. differential in yield between investment grade and highest-rated instruments may inch up over the medium term on these concerns. What is important is that the investor should be aware of the risk being taken and the compensation in terms of relatively higher portfolio running yield.

Unlock a world of Benefits! From insightful newsletters to real-time stock tracking, breaking news and a personalized newsfeed – it's all here, just a click away! Login Now!

Catch all the Business News, Market News, Breaking News Events and Latest News Updates on Live Mint. Download The Mint News App to get Daily Market Updates.
More Less
Published: 17 Sep 2018, 09:52 AM IST
Next Story footLogo
Recommended For You
Switch to the Mint app for fast and personalized news - Get App