How debt funds have their own share of risks
March 16, 2017 / 02:19 PM IST
A dealer walks past an electronic board in the investors' gallery at the Amman Stock Exchange November 21, 2011. Jordan's financial community hopes more mutual funds will be set up because that could revitalise the stock market, which is near seven-year lows. Greater institutional investment could offset a shrinkage of retail investor activity since the global credit crisis of 2008-2009 sent stocks tumbling. Picture taken November 21, 2011. To match Feature JORDAN-BOURSE/ REUTERS/Muhammad Hamed (JORDAN - Tags: BUSINESS) - RTR2UD9A
There has now been another instance of a mutual fund house finding the value of its schemes fall sharply due to a downgrade in the debt of a particular company. This should send out more warning bells for investors who could find the value of their investments in the mutual fund plunge sharply following such a development. The fact that this is happening in debt oriented funds is another reason for the investors to take a closer look at the entire issue and the manner in which this is working out. Here is the way in which investors should look at the portfolio of debt funds for their investment requirements.
The main consideration for investors when they put money into debt funds is the kind of returns that this might earn. There is very little attention that is given to the risk element that is present in the investment but as many are now finding out this can become a big hit for their investment. Debt mutual funds while promising a steady rise in the value of the investments are not risk free as many people think. There is an element of risk in the form of credit rate risk or interest rate risk that might be present depending on the nature and the type of fund. The consideration for investors when they look at debt funds is that there should be a proper construction of the portfolio and its holdings such that the entire situation is manageable from the risk point of view. It is important to pay attention to this aspect because it can no longer be ignored by the investors. There is a need to take a careful look at this entire arena and then one can make a proper decision on the matter.
Another belief of a lot of people is that it is only default in the debt holdings of some companies that one has to worry about. The default could lead to a situation wherein the fund has to write down the value of the investment but this is not the only situation in which the investor could face a hit. This is where a lot of people do not take the risks in debt funds into consideration. There can be times wherein the company has not defaulted but still there is a downgrading of its debt. In this case too, the mutual fund would have to write down a certain percentage of the value of the holdings and when this happens there can be a hit to the net asset value of the fund depending on the extent of the holding in the portfolio. This is also the reason why the ongoing financial performance and situation of various companies in the portfolio have to be taken into consideration by investors when they are evaluating the options.
Just because a fund has written down the value of the investment it does not mean that there is a loss that would be encountered. It could be that at a later date there is a part or full recover of the amount that has been invested in the company. In such a situation the net asset value of the funds that are affected could bounce back. The real challenge for the investor is to actually look at the holdings and the fund and then figure out whether this kind of comeback is going to be possible. If that is not the case then the investor would be better off taking the immediate hit whatever this might be and then getting out of the investment. This would be better then hoping for a reversal that might never happen.