Investors in credit risk funds are a worried lot. Credit risk funds in last one month (ended Sep. 26) period have fallen up to 2.7% (see the table at the bottom of the story). Yes, fallen. Let that sink in for a moment. These are debt funds, mind you. As a result, over the last 1-year period, credit risk funds have posted gains in the range of 2.4% to a maximum 5.9%.
Those kinds of returns are lower than even in bank fixed deposits. The recent events in bond markets have led to heightened volatility triggered by the downgrade of IL&FS followed with newsflows over DHFL. Things will take time to improve. If you don’t have over two years of time frame and the patience to stomach 6-9 months of volatility, you should consider exiting credit risk funds, according to experts.
The NBFC turmoil
According to a report by JM Financial: “The macro headwinds (i.e. elevated oil prices, rising domestic & global interest rates, and pressures on twin deficit etc.) have led to the hardening of yields (>150bps) in the last 1 year. On the other hand, banking liquidity (as measured in liquidity adjustment facility or LAF window) has turned into deficit (>Rs. 1.2 lakh crore) in the second week of September (primarily driven by advance tax outflows & half year ending) thereby putting further pressure on yields.”
Amidst tight liquidity conditions & rising interest rates, the recent credit episodes (likes of IL&FS, DHFL secondary market trade) have led to market fears over refinancing risks for NBFC sector, as a result leading to an expansion in credit spreads and, in turn, further aggravated liquidity conditions, the report further added.
Aadhar Housing Finance, MD & CEO, Deo Shankar Tripathi says: “The present scenario is very unfortunate which is a knee-jerk reaction on the IL&FS fiasco. Suddenly, all learned analysts started painting an adverse picture of HFCs and NBFCs. This has resulted in withholding the release of sanction facility by many banks to NBFCs & HFCs. Which is expected to derail the growth momentum. There seems to be an artificial liquidity crunch in the market.”
The lending reluctance toward NBFCs is expected to continue considering the uncertainty prevailing among capital market lenders towards the credibility of rating agencies and credit profile of NBFCs.
“With such reluctance continuing, the source of easy money for NBFCs is limited. Though we expect a switch from capital market borrowings to bank borrowings would be rapid, however, considering overall cap limits over sector-specific exposure, even banks would be pricing the debt accordingly. Though we see low probability for default (expecting timely RBI intervention), margin compression is inevitable for most NBFCs in the market,” says Jignesh Shial, research analyst, Emkay Global Financial Services.
According to JM Financial, “It is not an environment of solvency crises” but “more of illiquidity risk premium”.
Credit risk funds
While banks may be reluctant now to lend to NBFCs, but mutual funds have been regularly lending money to NBFCs. The problem is with existing investments by credit risk funds, who typically invested in lower ratings to earn more. So, they typically lend to AA or lower rated corporate bonds. Such funds are not suitable for all investors, even though the products are good for all kinds of interest rate scenario. Also, such funds are well positioned for investors with a holding period of at least three years.
According to a JM Financial sensitivity analysis, it is seen that the impact on 12-month returns on some of the high yielding funds could be in line with liquid fund returns, even in a scenario of yield hardening plus spread expansion.
“In our conjecture, we do not suggest a blanket exit call in credit funds / high yielding funds. The YTMs of these funds are rising. Once the financial conditions & bond yields stabilize, the carry will begin to better the returns profile. However, the investors in high yielding strategy need to have more than 2 years of time frame with patience to stomach 6-9m of volatility/underperformance over liquid funds,” said JM Financial.
The point about credit risk funds under-performing liquid funds is pertinent. Typically, liquid funds give almost equal to bank FD returns but deliver better tax-adjusted returns due to indexation benefit. The whole point of buying credit risk funds is getting better than liquid funds returns but at the cost of greater risk.
With the risk part of ‘credit risk funds’ coming to the fore, this category is not suited for investors with a weak heart and less time. “…investors with less than 2 years’ time frame with low-risk appetite and who have already completed three years can exit such funds selectively,” added JM Financial.
Debt markets are not immediately becoming calm seas; the waters can get rough again. The bond markets could extend volatility as crude prices have again crossed $80 a barrel extending pressure on the rupee & twin deficit and thus increasing the risks of further rate hikes.
Also, the liquidity conditions could remain tight on the back of three factors. One, currency leakage ahead of the festive season as well as election period toward the end of the year. Two, any RBI forex intervention to aid rupee will put pressure on liquidity. Three, again by Feb-March 2019, the seasonal phenomena of financial year end liquidity tightness could emerge.
“On account of the above mentioned factors coupled with high supply in the second half of the financial year, the bond yields could remain under pressure until Feb-March 19 (albeit with intermittent respite) and hence there could be possibility of continued underperformance of mark to market funds in general over liquid funds,” JM Financial said.
Credit Funds Performance
Credit Risk Funds
|Aditya Birla Sun Life Credit Risk Fund – Regular Plan (Erstwhile Aditya Birla Sun Life Corporate Bond Fund) |||-0.52||0.91||4.85||8.27||–|
|Axis Credit Risk Fund – Regular Plan (Erstwhile Axis Fixed Income Opportunities Fund) |||-0.3||0.98||3.92||7.16||–|
|Baroda Pioneer Credit Risk Fund- Plan A(Erstwhile Baroda Pioneer Credit Opportunities Fund) |||-0.33||0.86||4.55||8.54||–|
|BOI AXA Credit Risk Fund – Regular Plan(Erstwhile BOI AXA Corporate Credit Spectrum Fund) |||-1.72||-0.33||5||8.79||–|
|DHFL Pramerica Credit Risk Fund – Regular Plan (Erstwhile DHFL Pramerica Credit Opportunities Fund) |||-0.44||0.82||3.89||7.63||–|
|DSP Credit Risk Fund (Erstwhile DSPBR Income Opportunities) |||-2.71||-1.49||1.33||6.68||8.13|
|Franklin India Credit Risk Fund (Erstwhile Franklin India Corporate Bond Opportunities) |||-0.32||1.3||5.65||7.94||9.2|
|HDFC Credit Risk Debt Fund – Regular Plan(Erstwhile HDFC Corporate Debt Opportunities Fund) |||-0.49||0.78||3.16||7.53||–|
|ICICI Prudential Credit Risk Fund (Erstwhile ICICI Prudential Regular Savings) |||-0.3||0.95||4.86||7.47||8.66|
|IDBI Credit Risk Fund – Regular Plan (Erstwhile IDBI Corporate Debt Opportunities) |||-0.76||0.52||4.04||6.37||–|
|IDFC Credit Risk Fund – Regular Plan(Erstwhile IDFC Credit Opportunities Fund)||-0.37||0.67||3.03||–||–|
|Invesco India Credit Risk Fund – Regular Plan(Erstwhile Invesco India Corporate Bond Opportunities Fund) |||-2.23||-1.04||2.43||7.18||–|
|Kotak Credit Risk Fund Regular Plan (Erstwhile Kotak Income Opportunities) |||-0.36||1||4.63||7.74||8.67|
|L&T Credit Risk Fund (Erstwhile L&T Income Opportunities) |||-0.36||0.8||4.01||7.56||8.77|
|Mahindra Credit Risk Yojana – Regular Plan||-0.59||–||–||–||–|
|Principal Credit Risk Fund (Erstwhile Principal Credit Opportunities Fund) |||-0.18||0.97||5.43||7.34||8.25|
|Reliance Credit Risk Fund (Erstwhile Reliance Regular Savings Debt ) |||-0.34||1.1||4.6||7.62||8.52|
|SBI Credit Risk Fund (Erstwhile SBI Corporate Bond Fund) |||-0.23||1.16||4.16||7.63||8.75|
|Sundaram Short Term Credit Risk Fund(Erstwhile Sundaram Income Plus)||0.14||1.43||5.92||6.74||8.2|
|UTI Credit Risk Fund – Regular Plan (Erstwhile UTI Income Opportunities) |||-0.31||0.82||4.18||7.5||8.72|
|Source: Value Research|