Can You Ignore Default And Liquidity Risk While Investing In Debt Mutual Funds? - Outside View by PersonalFN

Helping You Build Wealth With Honest Research
Since 1996. Try Now

  • MyStocks


Login Failure
(Please do not use this option on a public machine)
  Sign Up | Forgot Password?  

Can You Ignore Default And Liquidity Risk While Investing In Debt Mutual Funds?
Jan 9, 2019

The Capital market regulator has been nudging mutual funds to focus on the quality of portfolios ever since mutual funds have started investing aggressively in low-rated debt instruments.

The capital market regulation issued reclassification norms to make investors aware of the risk elements and to instil portfolio discipline among mutual fund houses.

Yet, the fiasco of the IL&FS default sent shivers down the spines of investors when even liquid funds posted losses on account of their concentrated exposure to defaulting subsidiaries of IL&FS.

[Read: How IL&FS Rating Downgrade Will Impact Your Mutual Funds]

Since then the word through the grapevine has been that Capital market regulator might issue a short-term locking period for mutual fund investors. Economic Times dated November 12, 2018, carried a story on this topic.

There's no smoke without fire, indeed!

Mr Arvind Chari, head of fixed-income and alternatives at Quantum Advisors, had expressed a quite comprehensive view:

  • "At Quantum, we believe that Liquid Funds should not take credit risks so as to ensure that it meets the true objective of keeping it safe and liquid. We do not know what Capital market regulator is likely to propose for liquid funds and we have to wait and watch, but I don't think putting restrictions on redemptions is a good idea. Capital market regulator should propose that all assets are fully marked to market to ensure that the declared NAV is 'real'. It should also consider mandating that liquid funds do not take credit risks."

The Financial Stability Report published by the Reserve Bank of India (RBI) made a crisp comment in this regard. Below are the excerpts from the report.

  • It might be appropriate to consider investor level concentration limit on issuer to ensure diversification at issuer level. To improve liquidity in money market and liquid funds, valuation and maturity restrictions are under review by Capital market regulator. A mandatory liquidity limit may also be considered by them. In this regard, an effective ALM regime in non-banking financial sector may also enhance systemic resilience.

If you read carefully, RBI has been advising the industry to stick to the basics of investing.

--- Advertisement ---
13 Stocks to Buy in 2019…

Sarvajeet and Radhika, co-editors of Smart Money Secrets, track down the investments of 40+ of India's most successful investors, and share the best of these stocks with their subscribers…

They have identified 13 stocks (which you could consider buying right now) – for huge potential profits.

Click here to see how these stocks are identified – and how you could get access to these 13 stocks.

You must have heard umpteen times that diversification is the essence of portfolio management!

Those who aren't well versed with the basics of investment management, diversification simply means not putting all your eggs in one basket. It's not only important for you to diversify across various asset classes such as equity and debt, but also within each asset class. For example, when you are investing in fixed income assets, you may consider fixed deposits, debt mutual funds, and company deposits among others.

Similarly, a debt fund diversifies its portfolio across various securities, (maturities and the yield curve) depending on the objectives of the schemes.

But what about the issuer of debt instruments?

As you might remember, DSP Mutual Fund sold DHFL's commercial paper in the secondary market at a steep discount. This happened primarily because of illiquidity in the secondary market for such instruments. However, had it formed a significant portion of the outstanding debt of DHFL, it would have created a major problem for the company. Not only did it affect all future bond sales, but this would also affect its borrowing costs significantly for the papers with similar maturities.

[Read- DSP Mutual Fund's Sale of DHFL Bonds: Here's What You Need to Know]

Since mutual funds have become an important source of funding to some industries including Non-Banking Finance Companies (NBFCs), it's important to ensure that issuers of credit instruments aren't over-relying on one source.

We expect IL&FS and DHFL episodes to serve as lessons to learn since they were a result of systematic failure. Capital market regulator might take additional corrective measures so that the hard-earned money of small investors is not at risk in the future.

That said, even fund houses need to have proper due diligence and internal risk assessment policies in place to avoid taking exposure in such groups and must not rely completely on ratings that rating agencies provide.

It remains to be seen if Capital market regulator introduces liquidity limits for liquid funds or redemption restrictions for investors or both. In any case, investors need to be careful while investing even in liquid funds.

You shouldn't just look at the past returns, but you also need to analyse portfolio trends, risk preferences of the fund house, the robustness of investment processes and systems of the fund house, and the expense ratio among others.

Liquid funds could help be a useful avenue to park your short-term surplus, but don't assume that liquid funds are safe.

[Read: Why Your Money In Liquid Funds Is At Risk]

PS: Here is a strategy that has the potential to beat the markets in the next 7-8 years. Our 'Strategic Funds Portfolio for 2025' is backed by the 'core and satellite' approach of investing that many successful investors have adopted for long-term wealth creation.

If you're an investor looking for "decent investment gains at relatively moderate risk" PersonalFN's Premium Report, "The Strategic Funds Portfolio For 2025" could be a ready solution for you.

This report contains a ready-made portfolio of some of the best equity funds picked by our research team for the year 2025 that have the potential to generate lucrative returns over the long term. Click here to know more and subscribe.

Author: PersonalFN Content & Research Team

This article first appeared on PersonalFN here.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.


The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

Equitymaster requests your view! Post a comment on "Can You Ignore Default And Liquidity Risk While Investing In Debt Mutual Funds?". Click here!


More Views on News

Top 5 Stocks Mutual Funds Bought and Sold in March 2021 (Sector Info)

Apr 16, 2021

A look at what India's top equity mutual funds bought and sold in March 2021.

Kotak India EQ Contra Fund: Eliminating Emotional Bias (Outside View)

Apr 16, 2021

PersonalFN's analysis on the features and performance of Kotak India EQ Contra Fund.

A Warning About Bubbles (Fast Profits Daily)

Apr 16, 2021

Those who don't learn from financial history are doomed to lose their money.

11x Bankruptcy to Bluechip Stock: A Rare India Revival Story (Profit Hunter)

Apr 16, 2021

There is no stopping this 11-bagger stock from significant upside.

Market Crash: Picture Abhi Baaki Hai? podcast (Views On News)

Apr 15, 2021

Rahul Shah on whether another big crash is likely and the ideal strategy to counter it.

More Views on News

Most Popular

India: Recovery Stalled by Vaccine Games? (The Honest Truth)

Apr 13, 2021

Ajit Dayal on how India's vaccine strategy will impact the markets.

4 Stocks to Make Your Portfolio Immune to the Second Covid Wave (Profit Hunter)

Apr 6, 2021

Rather than predicting the market, successful investing is more about preparing well and placing your bets accordingly.

An India Revival Stock I'm Bullish On... (Profit Hunter)

Apr 9, 2021

This could take India to the position of 3rd largest economy.

Why Did the Market Crash on Monday? (Fast Profits Daily)

Apr 13, 2021

In this video, I'll you what I think is the real reason behind yesterday's market crash.

A Unique Sector for Short-Term Profits (Fast Profits Daily)

Apr 12, 2021

This ignored sector could deliver big short-term profits.


India's #1 Trader
Reveals His Secrets

Secret To Increasing Your Trading Profits Today
Get this Special Report,
The Secret to Increasing Your Trading Profits Today, Now!
We will never sell or rent your email id.
Please read our Terms


Apr 16, 2021 (Close)