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If you had invested in Taurus Asset Management Co. Ltd’s (AMC) debt mutual fund schemes, you’d have incurred big losses. On 22 February, net asset values of four of its debt schemes fell 7-12% in just one day (see table). 

Why? The credit rating of Ballarpur Industries—in which its debt schemes had invested—was downgraded that day by India Ratings & Research, a credit rating agency. The result was a dramatic fall.

This is not the first instance of credit risk adversely affecting debt funds. In August 2015, two schemes of JP Morgan AMC had tripped on the back of a downgrade in Amtek Auto Ltd’s credit rating.

When you invest in an equity fund, it buys shares of companies and hopes that their prices go up. If you invest in a debt fund, your fund invests in debt scrips of companies and gets paid interest. In simple words, debt scrips are loans given to different companies (borrowers). When the loan’s tenure is over, the company returns the principal to your debt fund (lender). Mutual funds are major lenders to firms, apart from banks.  According to the note that India Ratings & Research issued, “the downgrade reflects delays in debt servicing by the company...the company has also been unable to refinance its debt or elongate the maturity profile of its near-term debt obligations fully." 

Calls and text messages to Waqar Naqvi, chief executive officer of Taurus AMC and its fixed income fund management, were not returned. India Ratings & Research, too, didn’t answer calls. It has downgraded Ballarpur Industries’ credit rating from A3 to A4. This is just a notch above D, which indicates default on payments.  

Looking at the extent of fall of the NAVs of Taurus AMC's respective schemes, Ballarpur Industries has defaulted on repayment and the fund house has written down the entire value of the scrips. Hence the drastic fall in Taurus’ debt funds’ NAVs. Calls made and text messages sent to B. Hariharan, group director-finance, Avantha Group, which owns Ballarpur Industries, did not elicit any response. 

Three other fund houses had held debt scrips from Ballarpur Industries last year but they had sold these by the end of 2016. 

All mutual funds, including debt funds, carry risk. But it’s the fund manager’s job to mitigate the risks. For instance, a well-managed debt fund invests a large chunk in high-rated securities, unless its mandate to invest in low-rated securities. Taurus Short-Term Income Fund and Taurus Dynamic Income Fund had invested about 12% each in this scrip. According to the rules, a debt fund can invest a maximum of 10% in a single company’s scrip, but can increase it to 12% with the trustees’ approval. 

There’s more. Some debt instruments mature in the long term. Others, like commercial papers (CPs), mature in the short term. This is what Ballarpur Industries had issued to Taurus. 

“When mutual funds invest in CPs, liquidity of the scrip is very important... if there is a problem in such scrips, then it becomes very difficult for us to sell it and we incur a loss," said R. Sivakumar, head-fixed income, Axis Asset Management Co. Ltd. He added that a low credit rating also impacts the scrip’s liquidity. Here, too, Taurus slipped. It did not exit the company even when its credit rating slipped twice in 2016.  

Gurugram-based Ashish Chadha, a mutual fund distributor, said every mutual fund is vulnerable. But that doesn’t mean you should avoid debt funds completely. “You need to mitigate risks and that is where an adviser comes in," he added. According to him, one should diversify among fund houses and not invest in more than one scheme of a fund house.

That said, investors must remember that all mutual funds carry risk. “We really don’t understand the fact that the risk will be passed on to the investor. Most of us believe that if defaults happen, the fund house will absorb it," said Vinod Jain, principal adviser, Jain Investment Planner Pvt. Ltd, a Mumbai-based mutual fund distributor.

Jain referred to many instances when fund houses could not sell a troubled paper, and the AMCs were known—in private circles—to have absorbed the bad papers from their funds’ books in exchange for cash.

This is the practice that one of the three fund houses quoted above, which had Ballarpur Industries’ scrips, is also said to have indulged in. Mint couldn’t verify that this is what the fund house did. 

What happens is that the AMC buys (takes it on its own books) it from the troubled scheme in exchange of cash. The fund house incurs the loss but investors are spared.  Remember, mutual funds carry risk: the return is yours, so is the risk. But risk can be mitigated.

And that’s the good news.

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