Last year's Samvat 2075 has been one of turbulence for mutual funds, especially the debt mutual funds domain that, in first of its kind, saw erosion of net asset value (NAV) of their schemes.
The year saw debt investors losing some principal and the delayed payment of capital and interest. Some mutual fund companies even bought out the portion of bad debt to bail out investors.
The popular notion of equity funds having risk and debt funds are safe and the principal is protected got turned on its head when the IL&FS default in last September 2018 was followed by a series of defaults by Essel, ADAG, DHFL.
Pre Diwali 2019, for Samvat 2076, SEBI has fired a reformative but conservative circular on debt mutual funds with wide ranging implications.
In this article, we will focus on the unlisted commercial papers (CPs) and restrictions on credit enhanced debt papers. These twin measures severely restrict mutual funds from betting on high yield papers.
The SEBI circular of October 1, 2019 stipulated investments only in Commercial Papers i.e. CPs that are listed on stock exchange. CPs are instruments with a maturity period ranging from seven days to one year. They have a credit rating, but do not require collateral.
By relegating investments listed CPs only,SEBI seems to have added a second line of defence for quality CP papers. Listed CPs means equity level disclosure of risks by debt papers that makes information dissemination of highest standards. In case rating agencies slip up in assessing default risks, mutual funds holding listed CPs can exit on the stock exchange quoted price.
For listed CPs, if a SEBI probe finds loopholes in disclosure compliance, SEBI has the power to initiate action. This should make CP issuing corporate and investing mutual funds highly diligent in dealing with CPs.
The circular also mandated that debt schemes shall limit their investments in structured debt and credit enhanced debt upto 10 percent at scheme level and just 5 percent to a particular industry group.
During October 2018 to March 2019, the non-timely payment by the likes of Essel group , DHFL group to debt mutual funds lead to the erosion of upto 70 percent NAV of schemes that had a large exposure to single industry groups.
Looking at market circumstances and erosion of some corporate credibility, SEBI has pressed the precautionary button on conservative side with the October 1 2019 circular, essentially ringfencing risk factor for debt investors.
Its high time fund managers raise their risk management practice standard on their own, keep a better reputation of sound investment management before SEBI is forced to step in further. Higher conservatism comes with its own downside of low yielding returns.