The announcement by Franklin Templeton Mutual Fund on the winding up of six debt funds, was a jolt out of the blue.
All six funds are high yield-high risk (low credit quality) strategies with average effective maturity ranging from 6 months to 5 years.
Our fund research team put out a note and placed the funds under review.
Why this action?
The asset management company (AMC) cited a dramatic and sustained fall in liquidity in certain segments of the corporate bonds market on account of the Covid-19 crisis and the resultant lock-down of the Indian economy which was necessary to address the same.
At the same time, mutual funds, especially in the fixed income segment, are facing continuous and heightened redemptions.
The AMC if of the opinion that an event has occurred that requires these schemes to be wound up. It is also of the opinion that this is the only viable option to preserve value for unitholders and to enable an orderly and equitable exit for all investors in these unprecedented circumstances.
The fund company would possibly try to liquidate the holdings as and when they are able to – at reasonable valuations, which would be a long-drawn activity.
The Morningstar Investment Adviser team in India shares the impact of the above on their Managed Portfolios.
Since the launch (April 2019) of Morningstar Managed Portfolios in India, we followed a cautious approach to avoid high yield/low credit profile funds at the shorter end of the duration as the situation in the credit market looked grim. The overall sentiment further turned risk-averse with the chain of events unfolding in the credit market over the last 12-18 months. Lately, corporate bond spreads have widened again and are trading above their long-term averages.
However, we would like to reiterate our view on this segment. One needs to be mindful of the current stress in the credit market and the potential downgrades & defaults amid the economic slowdown, which is expected to worsen due to the global lockdown as the fight against Covid-19 continues and whether the risk to reward favors investments in this segment.
We favour Banking and PSU debt category over other categories as the former looked relatively more attractive than high yield credit strategies from a reward to risk perspective.
We hold two funds in this category; both majorly invested in high credit quality papers issued by banks and PSU entities and government securities.
We hold two funds here, one of which is majorly invested in government securities and runs an active duration management style. The other one, along with duration management, offers an element of accrual income via exposure to high-credit quality corporate bonds. We are comfortable with the managers’ duration management style and believe that both funds in this segment would be able to outperform the benchmark and peer group across interest rate cycles.
The exposure is via a 10-year constant maturity fund. The rationale of adding a constant maturity fund was to get a fixed duration exposure in the long-term debt segment for all four portfolios.
- Overall credit quality of the debt funds in our managed portfolios
On review, we believe that the overall credit quality of the debt fund in our managed portfolios seems fairly stable and liquid. The funds are mainly invested in government securities, banks, FIs, and PSU entities instruments with no exposure to high yield-low quality instruments. In this unprecedented economic situation, we are actively reviewing our views across asset classes and portfolio positioning.
What next?
Over the last few weeks, the Reserve Bank of India has announced a host of measures focused on improving the availability of credit, maintaining adequate liquidity, and easing financial stress. Some news reports suggest that central bank may consider extending a credit line to the asset management companies to handle redemption pressures.
Our advice
In such uncertain times and a weak economic environment, we reiterate our view and follow a cautious approach while investing in debt funds.
