Taking credit risks in shorter-tenure funds can help jack up returns considerably, boosting sales. Until a year ago, there were a sizeable number of funds with more than 60 per cent
in ‘AA’ and below-rated papers, according to experts. On an average, the ultra-short duration, low-duration, and short-duration categories had 26-28 per cent of their assets in 'AA'-rated papers and below as of April 2019, with several schemes having a far higher exposure, past data from Morningstar India showed. The medium-duration category had, on average, more than 50 per cent invested in these papers.
Over the past year, however, it appears that fund houses have become a lot more conservative. An estimated 80 per cent of the industry's fixed income portfolio was in high-rated papers, including those rated sovereign and AAA as of March 31. “Funds have become conservative in taking credit calls after the IL&FS fiasco and have reduced their exposure to papers rated AA and below," said Kapadia.
Market players believe the current crisis might be a good time for the regulator to tweak its categorisation norms and define credit profiles wherever applicable. For instance, a low-duration or ultra-short duration fund could be mandated to invest 65-75 per cent in the highest-rated papers.
The other option could be to divide each category into two - one sub-category that is allowed to take credit risks and the other that sticks to ‘AAA’-rated and sovereign portfolio.
Kapadia, for his part, believes that the regulator could look at allowing two or three credit risk funds per fund house (instead of one currently) that would invest based on differentiated strategies and/or tenures. “The portfolio yield used to give away the kind of credit risk a fund house was taking. Setting credit limits for debt funds
will make their performance more comparable and level the playing field among fund managers,” said a debt fund manager.
On the flip side, guidelines to lower credit risk or improve liquidity could result in lower returns. Also, setting new limits might not eliminate credit risk altogether, as even ‘AAA’-rated papers face the possibility of downgrades.
“Creating credit sub-categories will help investors gauge risk better. But the question is whether such products will sustain over market cycles given that in India the bond market has very little liquidity,” said a second manager.
Sebi had introduced scheme categorisation guidelines in October 2017, with an aim to declutter the fund ecosystem and distinguish schemes based on asset allocation and investment strategy.