- Post IL&FS Crisis, some debt funds have given negative returns
- This makes it necessary to choose funds having top-rated debt instruments in the portfolio
- A good rating increases the possibility of higher returns. Whereas, a rating downgrade raises question mark over the fund's performance
Recently, a few debt mutual funds, which invest in relatively safer instruments such as bonds, debentures, commercial paper and other debt securities, have strangely posted negative returns. Experts say the payment default from non-banking finance companies (NBFCs) and housing finance companies (HFCs) has led to such returns. But the real culprit is – Infrastructure Leasing & Financial Services (IL&FS) and the crisis it brought! The project financing company defaulted on loans it took from NBFCs and HFCs. This triggered a liquidity crisis for these companies and they had no option but to default on payments, due on bonds and other debt instruments, to mutual fund houses. This eventually reflected in the negative returns of debt funds.
In the aftermath of the IL&FS crisis on debt fund investments, it has become necessary for investors to choose the funds carefully to ride the safe path. So, what should you keep in mind before selecting a debt fund? Read on to know the same.
Table of Contents
Credit Rating of Debt Instruments
The recent crisis has made it imperative for investors to check the rating of debt instruments. The rating, which is assigned by various agencies such as Fitch, CARE and Moody’s, is a tool to assess whether the issuer can repay the debt. This ultimately dictates the performance of the debt fund. Let’s check out the significance of different ratings.
AAA – It represents a high degree of creditworthiness of the issuers who can easily repay the amount due on bonds, debentures and other debt instruments. The instruments having such ratings are symbolized as ‘Highest Safety’.
AA – It also boasts of a strong credit profile and bears a symbol of ‘High Safety’.
A – This implies that the issuer has adequate repayment ability.
BBB – This rating means the issuer can pay off the debt but faces more solvency risks in the advent of any change in financial and economic conditions. Such a rating means the instruments are moderately safe.
BB – It implies a moderate risk of default in servicing the debt obligations
B – This rating means a high risk of default on debt repayments
C – Instruments assigned with such rating pose a very high risk of defaults
D – Instruments are already in default or are expected to default soon
Keep an Eye on the Change in the Rating
The rating does not stay the same all the time. It goes up and down, tracking the changes in economic and corporate developments. While the rating upgrade increases the possibility of better fund performance, the downgrade is a cause of concern. So, you need to watch the rating closely and regularly to take the right call. If you choose a fund whose instruments are constantly getting downgraded, you should exit from there. Instead, invest in a debt fund whose underlying securities have a good rating or are getting a constant upgrade from the rating agencies.
Exposure of Assets to Different Instruments
To achieve investment diversification, fund managers can put the assets in different instruments with different ratings. But it’s the efficient mobilization of assets that will make a difference in the end. Ideally, the maximum chunk should go to AAA and AA-rated instruments. The fund you choose should have a very less portion of the assets in instruments with a lesser rating. So, even if the results are not encouraging from such instruments, it won’t disturb the equation of the overall portfolio.
It’s the performance that counts in the end. Doesn’t matter how good the fundamentals a debt fund may have, you must not invest in it if it has flopped consistently. You should choose a fund that must have given good returns and performed better than its benchmark over different periods.
Disclaimer – “Mutual fund investments are subject to market risks. Please read the scheme document carefully before investing”.