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Photo: iStock

Advisers fine-tune debt fund portfolios

  • After the Franklin Templeton Mutual Fund episode, as panic among clients is palpable, planners are changing strategies and adjusting portfolios to new needs
  • While some clients want to move into funds with lower credit risk, others want to switch out into lower-risk assets

Franklin Templeton Mutual Fund’s decision to shut down six of its debt schemes has caused unprecedented panic among investors. Mumbai-based financial planners Suresh Sadagopan and Steven Fernandes both saw at least one of their clients redeeming all investments in debt mutual funds and moving the money to fixed deposits.

“My client said that he wants to preserve the capital," said Steven Fernandes, a Sebi-registered investment adviser and founder of Proficient Financial Planners. “Different investors have different concerns. Some asked if they should move out of debt funds. Some asked if they should redeem investments from Franklin’s equity funds. But the most common question was whether their debt portfolios needed a change," said Sadagopan, founder of Ladder7 Financial Advisories, a Sebi-registered adviser.

Re-evaluating portfolios

As debt funds have been facing rating downgrades and defaults, most financial planners have systematically moved their clients’ money out of credit risk funds over the past months.

Sadagopan, for example, is looking at the percentage of papers that are rated AA or below in schemes where his clients have invested. “Earlier, we would be fine if, say, 20-25% of the portfolio had papers that are rated AA or below. Now we are only sticking with funds where such papers are 15% or below," he said.

Arnav Pandya, founder, Moneyeduschool, a financial literacy initiative, also follows similar evaluation criteria. “Almost all funds have papers rated AA+ or below. But I prefer schemes that have up to 10-15% lower-rated papers. In some cases, even 20% in lower-rated papers is fine, if there is enough diversification within those papers," he said.

Planners are exiting schemes that have papers rated AA or below to ensure that the redemptions in the fund do not hamper the returns. “AAA-rated papers are more liquid, and fund houses can meet redemption pressure if there is panic withdrawal. Lower-rated papers would be difficult to liquidate in the current environment," said Fernandes.

Some of them had clients’ money in the six affected Franklin schemes. But the investments were not significant for planners that Mint spoke to. The event, however, has made financial planners review the existing investments more stringently.

Changing criteria

The Franklin event has changed the way planners evaluated funds earlier. After the Securities and Exchange Board of India re-categorized mutual funds, financial planners looked at lower-rated papers in some categories. Now they are delving deeper into the portfolio for all categories of funds whether it’s low-duration funds, corporate bond funds, or any other. Two of Franklin’s funds included ultra-short-term and short-term funds.

Lesson from Franklin event
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Lesson from Franklin event

Typically, when evaluating a fund, financial planners use the assets under management (AUM) as one of the parameters. The size of the funds gives comfort that the investor base is diversified, and the fund is also able to effectively diversify its portfolio and keep exposures to individual papers low as a percentage of the AUM. But two of Franklin’s funds had considerable assets—over 7,000 crore as of 31 March. “The event was shocking due to the size of some funds. While we will continue to look at AUM, it won’t have the kind of weight we gave earlier," said Fernandes. “Now, it’s primarily about the portfolio and mandate of debt funds."

Earlier, many planners went by the explanations given by fund houses with proven track records. Now, many are taking these with a pinch of salt.

Avoiding credit risk

The recent events have shaken the confidence of investors, and many have asked their advisers to move to products that don’t have credit risk. In such cases, planners are opting for funds that have lower credit risk. For long-tenured investments, they include banking and PSU funds, gilt funds and Bharat Bond ETFs. “While gilt funds don’t have credit risk, they are highly sensitive to interest rate movement. They can be volatile in some periods and eat into the capital. So, they are not for all investors and work only for long-term investments," said Sadagopan.

Yet there are clients who insist on moving entirely out of debt funds into lower-risk assets, at least until the liquidity and economic situation improves. For such clients, most planners are looking at the savings bond that the Reserve Bank of India issues. It offers an interest rate of 7.75% and there’s no investment limit. Then there are traditional products such as bank fixed deposits.

Debt funds continue to be recommended as they invest in papers of multiple companies for diversification and are liquid. Also, they have the potential to offer slightly better returns than FDs and are more tax-efficient. Investors should not panic due to the recent developments, and, instead, choose products that meet their requirements and risk appetite after understanding the risks involved.

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