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Business News/ Opinion / When debt funds malfunction
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When debt funds malfunction

For firms that rate mutual funds, a methodology update is needed to build in information that goes beyond just credit ratings


But you said debt funds are safe. Financial advisers and mutual fund distributors must have heard this statement many times over the past week. The trigger was the fall in value of four debt schemes of Taurus Mutual Fund. The net asset values, or price, fell between 7% and 11% over just a day.

Mutual fund investors do not often see these kind of price crashes overnight even in their equity schemes—which are seen to be riskier than debt funds. Worse, the funds were ranked highly by most third-party rating agencies such as Value Research, Morningstar and Funds India (Mint50 does not have recommendations for liquid and ultra short-term debt funds and has done away with looking at star ratings while evaluating longer-tenure debt funds). Investors, distributors and advisers (correctly) find using a star rating an easy way to shortlist funds before they sift further.

What happened is this: on 22 February, credit rating agency India Rating & Research Pvt. Ltd downgraded the ratings of Ballarpur Industries Ltd from IND A3 (short term, investment grade) to IND A4 (speculative grade). It also downgraded its long-term issuer rating to IND D (default grade). The net asset values (NAVs) of four debt funds from Taurus Asset Management Co. Ltd saw a price shave of 7% to 11%. Read this story by Kayezad E. Adajania to know more:

The price drop happened because the fund house marked down the value of Ballarpur Industries’ securities held by it to zero as the firm was unable to make its payments of interest and principal on time.

That Ballarpur Industries has been in trouble has been known to the market for a while. Even a basic Google search will throw up stories over the last few years that point to tough times for the firm. Fund managers and asset management company (AMC) CEOs I spoke to said that most of them stayed away from this paper for reasons of prudence. “We don’t even buy their equity, let alone debt," said one CEO.

It seems that four AMCs held this paper, of which only Taurus has taken the price hit and passed it on to the investors. The other three either got group companies to buy it off the scheme or the AMC has taken the hit instead of the investors. What this means is that instead of allowing the NAV to fall, the AMC either transfers the paper from the scheme to itself or sells the paper to a group company. This happens at a price that protects the scheme value, but the AMC has to pay from its own capital for a paper that currently has no value.

Investors in three fund houses did not see the sharp drop that investors in Taurus’ schemes saw. While this is good for investors in the short term, the practice of taking the pain out of debt fund investing is itself a cause for worry because it gives a false sense of security to investors in a market-linked product.

We saw a story like this play out sometime back when Amtek Auto Ltd’s paper was declared junk overnight by credit rating agencies, causing a similar panic in the market. You can read about that here: 

So, who’s at fault? Was it the fault of the fund house that bought this paper despite enough warning from the market about the firm being in trouble and relying only on the credit ratings of the firm? Or is it the fault of the credit rating agency that dropped the rating to junk from investment grade over a day? One CEO I spoke to said that the job of a fund manager is to read the smoke signals and not just rely on the ratings. Clearly, the fund houses that bought this high-risk paper were milking the higher interest it carried.

The role of credit rating agencies too needs to be questioned. How does a paper go overnight from investment grade to junk? We should also ask about the role of the trustees. Mutual fund rules say that a mutual fund scheme cannot invest more than 10% of the fund value in securities of one firm. This limit can go up to 12% after trustee approval. So, why did the trustees approve buying more paper of a troubled firm? Who are the trustees that went ahead and approved this hike in the case of Taurus? Pages 3 and 4 of this document——have the names of Taurus Mutual Fund’s trustees.

The Indian mutual fund market is largely well regulated. But the capital market regulator needs to take a closer look at the debt fund part of the market. There is a need to make credit-rating agencies more responsible for their ratings. There is something wrong about the rating dropping like a stone overnight.

Securities and Exchange Board of India (Sebi) needs to get the trustees to do their job. Trustees are the custodians of investors’ money and faith. Few investors know that it is the trustees in a mutual fund who are responsible to them, and not the AMC. For firms that rate mutual fund schemes, clearly a methodology update is needed to build in information that goes beyond just credit ratings.

So should you return to fixed deposits?

No. Debt funds can almost totally reduce your need to use a bank deposit for short- and medium-term money. Debt funds give better tax- and inflation-adjusted returns than bank deposits. What can you do as a debt fund investor? Diversify. Don’t put the entire corpus in one scheme. Find a good adviser. Pay her for the value-add on portfolio creation.

Monika Halan works in the area of consumer protection in finance. She is consulting editor Mint, consultant NIPFP, and on the board of FPSB India.

She can be reached at

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Updated: 01 Mar 2017, 04:52 AM IST
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