Home / Money / Personal Finance /  Crisil report highlights debt fund categories with highest risk

A report by Crisil has highlighted the rating and liquidity profile of debt in various mutual fund categories, pointing out those, which are most exposed to credit risk. It also noted wide variations in individual schemes in different categories, suggesting that opportunities in debt funds are there if debt categories and schemes are carefully filtered.

According to the report, from July 2018 to February 2020, as many as 22 companies held by mutual funds defaulted. The damage from these defaults aggregates to 17,700 crore. Just four entities—IL&FS, DHFL, Reliance ADAG and Yes Bank accounted for about 16,000 crore of defaults.

Another way to look at the data is to see which debt categories were most affected. These were credit risk funds ( 4,346 crore), followed by medium duration funds ( 2,304 crore) and aggressive hybrid funds ( 1,902 crore).

Despite these statistics, debt funds as a whole do not look highly risky. The Crisil report highlighted that as of April 2020, 92% of the assets of debt funds were in cash, government securities, bank fixed deposits (FDs) and AAA or A1+ debt (A1+ is the short term equivalent of AAA).

However, once again, the individual debt category made a difference. This percentage in high-rated assets dipped to 37% for credit risk funds, which are required to mandatorily invest at least 65% of their assets in debt rated below AA+. It was also lower than average for medium duration (57%) and dynamic duration funds (74%).

Another facet of credit rating is the credit outlook that agencies put out. This is positive, stable or negative and indicates the possible future movement of credit rating for a security. The report said that overall exposure of debt funds to ‘negative outlook’ issuers rose from 5.9% in March 2020 to 7.6% in April 2020. However, a category wise differentiation played out.

In March, this was just 0.6% in corporate bond funds and 1.7% in banking and PSU debt funds. Credit risk funds had significantly higher exposure to such negative outlook issuers at 27.4%. However, even within this category, exposure to negative outlook issuers ranged from 2.14% to 97.61%. Ultra short term funds, medium duration funds and low duration funds came next with such exposures at 18%, 16% and 12%, respectively.

Crisil also looked at the liquidity profile of debt fund portfolios, their diversification and exposure to sensitive sectors. A similar story played out with wide variations in individual schemes coupled with overall improvement along with these parameters in the most recent April data.

“Things aren’t all bad. Indeed, dive a little deeper and there are streaks of silver— options among various categories of debt mutual funds that can help ride over the challenges being posed by the pandemic's economic blow," said the report.

“The overall debt mutual funds segment is seeing a shift to cleaner papers along with the reduction in allocation to illiquid instruments, which is a very good and healthy sign," said Rushabh Desai, a Mumbai-based mutual fund distributor.

“There is a wide variation within the debt categories in terms of illiquid and credit risk instruments. Investors with a three-year time horizon can look at corporate bonds and banking PSU funds as their core portfolio and for shorter duration liquid, arbitrage, ultra short and low duration funds," he added.

Investors should take a nuanced approach to debt funds. They should pick funds that are suited to their goals, filtering first by category and then by the scheme.


Neil Borate

Neil heads the personal finance team at Mint. A former colleague called them 'money nerds' and that's what they are. They cover topics like mutual funds, taxation and retirement, all to improve your chances of building wealth. Neil graduated with a degree in law and economics. He passed the CFA Level I exam and began his writing career at Value Research, a mutual fund research firm in 2016. He joined the personal finance team Mint in 2019. Everyday, the Mint Money Team tackles personal finance questions such as where to invest and where to borrow, through articles, charts and reader queries. They also have a daily podcast - 'Why Not Mint Money' and an annual ranking of mutual funds - the Mint 20.
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