Securities and Exchange Board of India (SEBI) has asked fund houses to disclose maximum interest rate risk and maximum credit risk of all debt schemes from December 1, 2021.
Interest rate risk is measured by the Macaulay Duration of the scheme while Credit Risk will de be denoted by Credit Risk Value (CRV). The schemes will be placed in a nine-grid box which will denote the Potential Risk Class matrix (PRC).
The Credit Risk Value of the scheme will be the weighted average of the credit risk value of each instrument in the portfolio of the scheme, the weights based on their proportion to the assets under management (AUM).
Similarly, Macaulay Duration at the scheme level will be the weighted average of the Macaulay Duration of each instrument in the portfolio with the weights being based on their proportion to the AUM. The value of the debt instrument to be considered for calculating AUM has to include the accrued interest i.e. dirty price of the instrument.
The debt securities will be assigned a numerical rank from 13 to 1 based on their credit rating. For instance, G-Sec/State development loans/Repo on Government Securities/TREPS/Cash are assigned a value of 13. AAA securities get a value of 12, AA+ get 11, while below investment grade get a value of 1. Higher the credit rating higher the value and vice versa.
Credit Risk
- Class A (CRV >=12): Relatively low credit risk
- Class B (CRV >=10): Moderate credit risk
- Class C (CRV <10): Relatively high credit risk
Interest Rate Risk
- Class I: (MD<=1 year): Relatively low-interest rate risk
- Class II: (MD<=3years): Moderate interest rate risk
- Class III: Any Macaulay duration: Relatively high-interest rate risk
For instruments having short term ratings, the credit risk value shall be based on the lowest long term rating of an instrument of the same issuer (in order to follow a conservative approach) across credit rating agencies. However, if there is no long term rating of the same issuer, then based on credit rating mapping of Credit Rating Agency (CRAs) between short term and long term ratings, the most conservative long term rating has to be taken for a given short term rating.
If an open ended Short Duration Fund wants to invest in securities such that its Weighted Average Macaulay Duration is less than or equal to 3 years and its Weighted Average Credit Risk Value is 10 or more, it would be classified as a scheme with ‘Moderate Interest Rate Risk and Moderate Credit Risk’. Here’s how the position of the scheme in the matrix will be displayed by AMCs for this example.
The maximum interest rate risk which the above scheme can take would be in terms of the Weighted Average Macaulay Duration of the scheme and the same should be less than or equal to 3 years. The maximum Weighted Average Credit Risk which the scheme can take would have Credit Risk Value of 10 or more. Both the maximum interest rate risk and maximum credit risk would be reflected in the above matrix. By virtue of its placement in this position, the scheme would have the flexibility to take interest rate risk and credit risk below the maximum risk.
“Subsequently, once a PRC cell selection is done by the scheme, any change in the positioning of the scheme into a cell resulting in a risk (in terms of credit risk or duration risk) which is higher than the maximum risk specified for the chosen PRC cell, shall be considered as a fundamental attribute change of the scheme in terms of regulation,” states the circular.
Mumbai-based mutual fund distributor Rushabh Desai says, "Many investors assume liquid and ultra-short duration debt funds are safer but what they don’t know is that these funds are comparatively safe in terms of interest rate volatility risk. These funds can take exposure to low credit quality instruments putting investors money at high risk. In the same way, gilt funds without duration cap are technically credit risk proof but can take exposure to longer duration instruments putting the fund and investors to interest rate volatility risk. PRC is an excellent move by SEBI which will tell investors the maximum risk a debt fund can take within each of its categories based on the fund’s credit quality and its duration. This will help investors not get mislead and will give absolute clarity about the potential risks a debt fund can take."
Mutual Funds will have to inform investors about the classification in one of the 9 cells and subsequent changes, if any, through SMS and by providing a link on their website referring to the said change.
Access the circular here.
