Debt defaults left debt investors in deep trouble in 2018

If 2018 was decidedly the year of systematic investment plans in equity funds, it was certainly not the year of debt funds. For starters, the year started with volatile returns on benchmark 10-year government securities (G-sec), and for most of the year, market-wide returns continued to rise. to augment. This has contributed to dismal returns for debt funds. Also in the shorter term, liquid and very short term fund returns have fallen to levels of 5.5-6% annualized return, down from around 8% in 2016.

However, the real obstacle arose in the second half of 2018 with the default on interest payments and the subsequent deterioration of the debt securities of IL&FS group companies. This marked a historic change in perception given that, until then, IL&FS was an AAA rated debt obligation and was assumed to be at the highest level of security when it comes to payments. Overall, as earnings failed to recover significantly, overall credit risk funds saw their returns fall.

Within days, certain securities issued by companies in the IL&FS group were downgraded from the highest rating to the default rating. This rapid and unforeseen change has left mutual funds exposed to these loss-making securities. Now, it would be acceptable if all the losses were recorded in high risk debt funds. However, it turned out that many investors in short-term income funds and very short-term funds also got caught on the wrong side and saw their plan’s net asset value drop.

The intermediate losses of these short-term funds were not easy to bear and, as a result, the paybacks, especially from large institutional and private investors, began to be felt almost immediately. To fund these losses, asset managers had to sell other securities.

The perception around the ability of non-bank financial companies to generate short-term funds to make repayments began to be questioned and a systemic panic soon erupted that drove lenders away from this segment. Yields have skyrocketed and all of this has resulted in volatile returns from debt funds.

According to Khyati Mashru, Founder and Chief Financial Coach, Plantrich Consultancy LLP, “While there is a lot of awareness around equity, for debt investments, people are not so aware. We need to proactively communicate on how the performance of these funds is being performed. Debt funds offer superior returns compared to term deposits, but that comes with some risk – many clients don’t understand it. ”

In 2018, debt funds as a category recorded negative net inflows of ?? 1.63 trillion, of which ?? $ 0.70 trillion was released in September and October 2018, the two months most affected by the NBFC crisis.

No one wants to be struggling with bad assets. For MF investors, access to liquidity means that if an ILFS-like event occurs, they can exit just as quickly, even if it is at a loss. But the system itself has to look for buyers in other securities in order to generate cash for further redemptions. In addition, new investments are difficult to find in such times.

Given the illiquidity of debt markets, a vicious cycle ensues where system returns suffer unduly. To avoid this kind of situation and recognizing the binary nature of debt investing, Sebi has since authorized (December 12, 2018) UCITS to create side pockets to separate bad assets.

According to R. Sivakumar, Head of Fixed Income, Axis Asset Management Security Ltd, “When there is a credit event, it is difficult to accurately mark to market the failed security. While funds depreciate the value of downgraded securities, investors may suffer more if the recovered value is less than the depreciated value. ”

Side pockets help keep the right wallet as it is so the need for distress buyouts can be minimized. The bad security is moved to another pocket whose structure is closed and the daily value thereof is managed separately. If the fund can get the money back, investors who have been affected can get their contributions back for good reason.

Sebi has yet to provide the details of how this will work. It is hoped that while this will adequately address the issue, asset managers will also exercise restraint in using this facility.

While inflation is at its lowest level in many months, we are once again talking about falling interest rates.

This could be the silver lining that debt mutual fund investors are looking to start 2019 with.

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Carol M. Barragan

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