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In March 2020, debt mutual funds (MF) saw their second-largest outflows of 1.94 trillion because of liquidity worries spawned by covid-19. It has been an about-turn thence. Between April 2020 and November 2021, the industry saw as much as 3.29 trillion of net inflows. That, coupled with mark-to-market gains of underlying assets, has meant debt mutual fund portfolios surged to a record 14.74 trillion in August 2021. They closed November at 14.52 trillion. This sharp recovery in assets has also been supported by improvement in the portfolio profile of debt MFs.

We looked at three major components of the portfolio of open-ended debt mutual fund portfolios: Credit rating composition, liquidity of securities, and sensitive-sector exposure. The last component was based on Crisil Research’s Industry Risk Score.

Ratings profile: The industry’s aggregate investment in top-rated paper, government securities (G-secs) and state development loans (SDLs) has increased 700 basis points (bps) to 94% in October 2021 from 87% during the middle of the liquidity crisis in 2020.

Issuers with a negative rating outlook in the debt MF portfolio declined to less than 1%, in October 2021 from a high of ~7% in April 2020, showing significant improvement in the overall ratings profile of the invested money.

There was a material improvement in the ratings profile across categories. Medium-duration, dynamic bond and ultra-short funds with notable exposure to lower-rated paper in March 2020—at 49%, 33% and 31%, respectively—have seen those respective numbers fall to 35%, 13% and 9% as of October 2021.

Liquidity profile: At the peak of the crisis in March 2020, the industry’s exposure to liquid issuers stood at around 72%; this increased to 82% as of October 2021.

The profile of liquid issuers continued to be skewed towards G-secs, SDLs and AAA-rated papers, with their share increasing to nearly 99% from 97% in March 2020.

Almost all debt categories saw an improvement in their liquidity profile. Credit-risk and medium-duration funds reduced their exposure to illiquid issuers to 38% and 22% in October 2021 from 58% and 35%, respectively, as of March 2020.

Exposure to sensitive sectors: The industry’s exposure to Crisil-defined sensitive sectors has declined, with the overall asset exposure shrinking to less than 30,000 crore (2%) of the category assets, as of October 2021, from 58,000 crore (6%) as of April 2020

Exposure to sensitive sectors, too, declined across most categories, with credit-risk funds and medium-duration funds witnessing the sharpest plunge to 9% and 8% in October 2021 from 27% and 23%, respectively as of March 2020.

Debt MF
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Debt MF

A potential third wave of the covid-19 pandemic is the key near-term risk to this credit outlook. Any sharp withdrawal of stimuli by global governments and regulators will also be a key downside risk over the medium term and could impact the credit profiles. That, in turn, would impact mutual fund portfolios. It is important look at debt funds through multiple lens and not get fixated by a single parameter before making their investment decisions. A proper review / monitoring mechanism should take precedence in their investment planning to help evade the risk associated with bad choices.

Jiju Vidyadharan, senior director, Funds & Fixed Income Research, Crisil.

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