Joydeep Sen
The common refrain of debt fund investors is that returns nowadays are muted and lower than expectations. In some instances like liquid funds, returns are lower than bank term deposits. However, something positive is brewing in the background. And no, we are not going to give you high hopes about next year, that returns will improve significantly. We are talking of something structural, about the framework for debt funds.
Let’s go back in time, three years or so. The atmosphere was about defaults by certain issuers. It started with IL&FS in September 2018, and one by one, many others broke. DHFL, ADAG group entities, and quite a few others. Even a bank; additional tier 1 perpetual bonds of Yes Bank were written off by the Reserve Bank of India (RBI) in March 2020. In the same month, at the start of the pandemic, there was significant redemption by foreign portfolio investors in debt, putting pressure on the system when liquidity was tight. Due to these systemic liquidity issues, even liquid funds gave negative returns for a few days. Franklin Templeton faced significant redemption pressure due to negative sentiments and on April 23, 2020, they shut down six funds. People were scared of debt funds.
The positive developments
Franklin Templeton payback: The Supreme Court of India appointed SBI Mutual Fund as the caretaker for the sale of assets in the six shut schemes. As on April 23, 2020, the total quantum in those six schemes was Rs 25,215 crore. Till date, the amount paid back is Rs 26,098 crore, which is 103.5 percent of the initial amount, i.e., investors have got more than the amount locked in in April 2020.
Moreover, the cash component in those six funds as on date is Rs 231 crore. The value of the portfolio in those funds, apart from the cash component, is Rs 1,121 crore, which is at valuation prices given by agencies Crisil and Icra, subject to realisation in the market. Adding up the three components—money paid back plus cash plus remaining value in the six portfolios—we arrive at Rs 27,450 crore. This is approximately 109 percent of the initial amount of Rs 25,215 crore.
More than the nitty-gritty of the numbers mentioned above, what is important is the end result. Just go back about two years, to April/May 2020. There was an air of despondency, lack of confidence in the system for debt funds and withdrawal symptoms.
Corporate default cycle stabilises: The multiple defaults mentioned earlier were not so much due to an economic slowdown but due to the non-performing asset or NPA clean-up drive launched by the regulator and the government. The corporate default cycle seems to be over now. Since the Yes Bank bond write-down, there has been no fresh major breakout. The media reports on RBI action on ADAG group companies and Srei Group are earlier cases being actioned. But broadly, when we look at the multiple defaults between September 2018 and March 2020, with something breaking out every other day, we have stabilised now.
Improvement in corporate credit quality: In the trying times of the pandemic and economic slowdown, the corporate sector did a wonderful job of reducing debt and managing interest coverage. Rating agencies publish a credit ratio which compares the number of credit upgrades in that period to the number of downgrades. A ratio of more than 1 is positive, as it signifies more upgrades than downgrades. In the second half of FY22, or October 2021 to March 2022, the Crisil credit ratio was as high as 5. There were 569 rating upgrades against 113 downgrades. In the first half of the year or April to September 2021, the Crisil credit ratio was 2.96. In FY22, Icra upgraded 561 entities against a downgrade of 184 entities or a ratio of three times.
Conclusion
Market-level fluctuations are part and parcel of any market, be it equity or debt or commodities. Price levels work in cycles and if you stay the course, you will reap your returns. What is important is the system. In the National Spot Exchange case, investors suffered due to systemic failure. When a debt issuer defaults, recovery depends on the legal process. Today returns from debt funds are muted not due to any systemic issue but due to interest rates moving up or bond prices coming down. The Franklin Templeton incident in April 2020 meant a lock on liquidity and some investors apprehending that money is lost. The payback shows that the shutting down of six funds was not due to any credit default issue but due to market liquidity constraints. Hence, investor opinion about debt funds and asset management companies must not be swayed by once-in-a-century black swan events like the pandemic and the resultant economic slowdown which could never have been anticipated. The improvement in corporate credit quality shows that the framework is robust. Returns are muted today and are set to stabilise gradually—stay the course.
Joydeep Sen is a corporate trainer and author
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