A look at 6 credit risk funds

By Kaustubh Belapurkar |  19-07-19 | 
 
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Kaustubh Belapurkar, Director of Manager Research, Morningstar Investment Adviser India.

Credit risk funds are debt funds that invest at least 65% of their corpus in AA or below rated corporate bonds.

A look at the 1-year performance as of today, the best performer delivered 8.49% and the worst, -48%. The category average is 1.34%, which goes up to 4.88% for 3 years.

Morningstar's analysts Himanshu Srivastava and Nehal Meshram took a look at a few of these funds over the past seven months, and assigned Neutral, Bronze and Silver ratings accordingly.

Reliance Credit Risk

  • Star Rating: 4 stars
  • Analyst Rating: Neutral
  • Date of Analysis: December 2018
  • Analyst: Nehal Meshram
  • Fund Manager: Prashant Pimple
  • Credit Quality: Medium
  • Interest Rate Sensitivity: Limited

Credit selection at absolute high yields and attractive spreads without carrying high-duration underpin this offering. Economic, credit, and liquidity analysis form the pillars of the investment process. The investment team incorporates the views of key external economists and in-house economists on factors such as gross domestic product growth, inflation, fiscal deficits, and trends in government borrowing, which are important for managing this fund.

The investment process is research-intensive, and credits and structures are well researched for yield enhancement. The investment universe of about 425-450 companies is tracked by the experienced research analysts while the investment team focuses on the business, management, financial health, and promoter group.

They also use the analysis of sell-side research and credit rating agencies to form a view on companies' creditworthiness. The AMC has a predefined template for the duration and credit risk that funds can take based on its mandate. These ranges become the boundaries within which a manager operates. The exposure limits are decided by the head of fixed income, Amit Tripathi, or the investment committee, depending on inputs provided by the credit research team, type of issuer, and the tenure of the issue. Periodic reviews are done based on the quality of the credit to determine if a change in position is required.

Read the brief analyst note here

HDFC Credit Risk

  • Star Rating: 5 stars
  • Analyst Rating: Bronze
  • Date of Analysis: December 2018
  • Analyst: Nehal Meshram
  • Fund Manager: Shobhit Mehrotra
  • Credit Quality: High
  • Interest Rate Sensitivity: Limited

The fund’s investment strategy lies in the manager’s ability to go down the credit curve to generate alpha. The in-depth understanding of companies has helped Mehrotra in identifying securities offering attractive spreads.

The fund invests at least 65% of its net assets in bonds rated AA and below. Within the credit space, the fund is conservatively managed with higher exposure in good-quality AA and AAA rated bonds, which put together makes a quality portfolio. The fund typically maintains 15%-20% in AAA, 40%-50% in AA, and 30%-40% in AA and below rated instruments. On an overall basis the fund's credit rating is tilted towards low risk with AA/AA- kind of investments.

In terms of duration, the manager maintains a moderate duration in the range of 2.5-3 years. The fund is well diversified with around 70-80 instruments across sectors. The individual security exposure is capped at 5% and the size of the bets decreases progressively as a company's financial strength and market cap decrease. To counterbalance the liquidity risk in the portfolio they have strong AAA rated papers such as PSU, PFC, REC, NHCI, IRFC, and NABARD, which are extremely tradable segments. Some of its single A credits are also very strong in terms of promoter group and management--for example, Tata International and Sprit Textile. So even 30%-40% exposure in such instruments, which are considered high-risk, does not make the fund riskier.

Read the brief analyst note here

Franklin India Credit Risk

  • Star Rating: 5 stars
  • Analyst Rating: Silver
  • Date of Analysis: December 2018
  • Analyst: Himanshu Srivastava
  • Fund Manager: Santosh Kamath
  • Credit Quality: Medium
  • Interest Rate Sensitivity: Limited

The manager seeks to add value through security selection rather than making substantial adjustments to the fund's duration. Expectedly, the investment approach relies on fundamental research; the latter entails combining both qualitative with quantitative analysis.

The investment team prepares the coverage list with a strong focus on factors such as the company management--its background and track record, financial strength of the promoter group, and corporate governance standards. Regular company visits are an integral part of the strategy. Meetings with company management are followed by rigorous quantitative analysis in which the focus is to get a measure of the company’s creditworthiness. The team will study the company’s cash flow, future capital expenditure requirements, assets, and leverage ratios. On this front, the team also makes use of the Franklin Templeton equity team’s expertise and uses analyses of the sell-side and credit rating agencies to form a view on a borrower’s ability to repay. Investment decisions are based solely on the team’s views. Particularly, the manager attempts to avoid entities he views as offering a poor risk/reward trade-off.

An independent risk-management team ascertains the portfolio and company-specific limits, making the process holistic. We think this is a thorough and proven process with which the manager and the team are at ease.

Read the brief analyst note here

Kotak Credit Risk

  • Star Rating: 4 stars
  • Analyst Rating: Bronze
  • Date of Analysis: February 2019
  • Analyst: Nehal Meshram
  • Fund Manager: Deepak Agrawal
  • Credit Quality: High
  • Interest Rate Sensitivity: Limited

The fund house has a tight structure put in place to evaluate the credit matrix and take a transaction-based approach while deciding on investments. The strategy is more focused on taking small-duration bets and invests primarily in good-quality high-yielding assets. The manager seeks to identify duration bets through macroeconomic factors, by incorporating the views of internal and external economists. The strategy is conservatively managed and credit analysis is divided into banking, NBFCs, and manufacturing debt. These are further demarcated into three buckets based on the strength of the business, management, and corporate-governance standards.

Moreover, the surveillance has shot up after the recent spate downgrades in the market. The NBFC and housing finance sector, which was evaluated on a quarterly basis, is now tracked on a monthly basis. The team also leverages the expertise of the equity team at Kotak AMC and Kotak Bank. The qualitative assessment is then followed by rigorous quantitative analysis wherein financial ratios such as leverage, coverage, and solvency ratios are considered. While constructing the portfolio, the manager follows a proprietary model to determine the exposure that he can take in each issuer. They also have an independent risk-management team which ensures that the limits are being adhered to. The presence of an experienced investment committee is helpful and makes the investment process more holistic.

Read the brief analyst note here

SBI Credit Risk

  • Star Rating: 5 stars
  • Analyst Rating: Neutral
  • Date of Analysis: May 2019
  • Analyst: Nehal Meshram
  • Fund Manager: Dinesh Ahuja

The fund's investment strategy is to take a significant credit risk while minimizing interest-rate exposure. It invests across the capital structure with a bottom-up investment process and applies a combination of quality and liquidity filters to the universe. This helps eliminate speculative companies with excessive debt or negative earnings. Investments in credits are not based on interest-rate movements, reflecting its passive duration strategy. The team uses various qualitative and quantitative parameters and puts a lot of emphasis on the company's management, business, and financial health. It looks into the covenants in-depth that protect from downside scenarios.

It also uses the analysis of sell-side research and credit-rating agencies to form a view on the creditworthiness of companies, but to a limited extent. The credit committee then reviews the rated securities, and the approved securities are assigned credit and tenor limit. Currently, the investment universe is composed of 320 companies.

While constructing the portfolio, the managers have the flexibility to implement the trades with reasonable leeway to express their views.

The risk-management team also periodically reviews the portfolio to ensure that the managers adhere to the guidelines. We believe that the flow of ideas is effective, but we need to assess the team’s execution of the process over different market conditions.

Read the brief analyst note here

DSP Credit Risk

  • Star Rating: 3 stars
  • Analyst Rating: Neutral
  • Date of Analysis: June 2019
  • Analyst: Nehal Meshram
  • Fund Manager: Saurabh Bhatia
  • Credit Quality: Medium
  • Interest Rate Sensitivity: Limited

The process is built around strong research and risk-control measures. Despite this, the approach had mixed results through recent credit cycles and doesn’t offer a clear advantage. The frequent change of portfolio managers also resulted in below-average execution. The fund invests predominantly in high-yielding corporate debt, and the managers seek to add value mainly through security selection rather than tweaking the portfolio duration.

The fund's fundamental attribute has undergone a change in 2014, pursuant to which it maintains duration in the range of 1.75-2.5 years. Besides that, the fund has also descended the credit curve in line with SEBI’s mandate. The investment process involves a top down approach that focuses on macroeconomic trends combined with a bottom-up selection with a strong focus on factors such as company management, track record, financial strength of the promoter group, and corporate governance standards.

While evaluating lower-rated credits, issuers are monitored closely, and management meetings are held more frequently followed by rigorous quantitative analysis. The risk and quant analysis team defines he credit risk limits, and any new issuer has to be approved by the credit committee. The team has strengthened the processes recently from the perspective of credit risk funds and made conscious efforts to maintain a high market liquidity profile of the portfolio.

Read the brief analyst note here

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