Dear newbie debt mutual fund investor, let us first congratulate you for believing in debt MFs. Your MF distributor, financial advisor, bank branch official or faceless online platform may have told you that debt funds, often also referred to ‘fixed income’ funds, are better than bank deposits that your parents swore by. Yes, debt MFs are better in some ways than FDs. But, that’s like saying Virat Kohli is better than Sachin Tendulkar or IPL is better than ODIs! It is not the complete picture.
At RupeeIQ, we believe in telling investors the bare facts and then let them make informed decisions. Of course, we share our opinion too but that is intended to help you. The last few months have taught us a few lessons about debt funds and these form the basis of the five harsh truths that India’s new debt mutual fund investors must be aware of. Make no mistake, our purpose is not to discourage you from investing in debt MF schemes, but rather make you aware. Read on.
1. Fund-houses are flexible in terms of communication
Asset management companies (AMCs) or fund-houses do not have an industry standard in terms of communicating with you about uncomfortable truths. They can bear an uncanny resemblance to those young kids who devise new ways of hiding a not-so-good report card. Yes, as funny as it sounds, that’s how it is. On TV, video platforms, and print publications, you may see industry experts talk about “transparency” of the MF industry, but they can take liberties.
The fund houses will SMS, email, and WhatsApp you about changes in total expense ratio (i.e cost of the fund for an investor). They will put advertisements in the newspaper about changes in investment strategy, exit load, fund manager change, and dividend declaration. But, when it comes to owning up about bad investment choices, the fund houses may try to avoid such information. It is like the ‘don’t ask, don’t tell policy’. So, don’t be surprised dear debt MF investor.
Truth is that problems in debt MF investments may not be easily available or found in the addenda/notice section of the AMC/fund website. You could try to find them in the regulatory section, and good luck getting it easily. Some fund houses may just send you an email about it and we would have to hope that you did not miss it. The onus is on you to read each and every email. So, don’t delete fund-house emails or mark them as ‘spam’. Read all the emails they send, even if they seem boring.
2. The timing of harsh truth intimation varies
Anybody who has dealt with terminally ill patients knows that there are two types of family members. The first type informs the patient about the illness. The second type delays informing for as long as possible, worrying that the patient might suffer more when confronted with the truth. The Indian MF industry seems to be in the second group.
Debt MF managers and company officials may know about problems in their investments in companies. Investing is not a zero-error profession, we agree. But if the money belongs to investors, do they have the first and instant right to know that some things haven’t gone as planned or as expected? Unfortunately, there is no broad consensus on this matter. Some are pro-active and believe in the timely dissemination of information. Others not so much.
All this means you may be told the harsh truth about your debt MF investment when it is no longer possible to hide it. News reports may have written about it, putting pressure on the fund house to share more details. Over the past few months, we have seen that the MF industry’s top executives who share their two cents on country, economy, industry and company-specific information on the social media almost every day, hardly take to the same social media to announce uncomfortable things. They may know a few things before-hand, but they will not share the information immediately. They will take their sweet time when it comes to disclosing harsh truth. They will wait till the end of a transaction or planned maturity of a scheme.
3. Take MF scheme names very seriously, and very literally
Some say, what’s in a name? If you are a mutual fund investor, especially investing in debt schemes, the name is very important. Do not ignore them as mere marketing gimmicks.
A debt scheme which falls under ‘credit risk’ fund category actually has credit risk. This means the fund invests in risky credit/debt instruments. High risks bring high returns, but they can also mean high losses, at least temporarily. Take the words ‘credit risk’ literally.
We can give you another example. There is a category of debt schemes called ‘fixed maturity plans’. Do not become confused with the word ‘fixed’. Read it in its entirety. ‘Fixed maturity plan’ (FMP) means your investment is locked for a ‘fixed period’ of time. The maturity date is known when you invest. However, do note that fund houses may extend the maturity time by taking your permission.
Understand that the words ‘plan’ in ‘fixed maturity plan’ means that all this is at best a plan! There is no assurance that the investment objective of any debt scheme will be achieved — this is written clearly. Buyer beware. If things go south, the MF officials may tell you that you should have been more careful before investing. So, beware.
4. Understand the meaning of tough-sounding words used by debt fund managers
Debt funds may be simple products, but the MF industry makes it sound greek. Yes, this also happens. While retail investors have some basic idea about equity markets, our knowledge about how debt/fixed income markets are woefully inadequate. Fund managers and fund houses do not take any extra effort in explaining things to you. The AMC websites will have a dictionary of terms or glossary, but do not expect that you will understand their meaning so easily.
Before retail investors started coming into debt MFs, these schemes were only sold to corporates who had large treasury requirements. The treasury departments of companies have CAs, finance officers and a whole of host super-qualified people who understand the terms used by debt fund managers. But, for the retail investor, things are tough to understand. Just because some retail guys invest in debt MFs does not mean they understand it fully.
Terms like ‘duration’, ‘short end rates’, ‘accrual’, ‘spread’, ’10 year’, ‘SDL’, ‘yield’, ‘AAA corporate’, ‘coupon’ etc. are used regularly. Try to understand the meaning of these terms. It will not happen quickly. You will need to spend time and do it. A large part of the financial services industry uses big and complicated words, ironically, to simplify things! As an average investor, your job would be to come to their level. This would mean learning the basic of debt funds and how they work. This will give you an automatic understanding of why certain terms are used together.
5. Yes, debt funds do post negative returns
Mutual funds manage your money. You give them money and they invest it as per the scheme objective. The purpose of any mutual fund scheme is to generate positive returns. Who would want to lose money, right? Equity mutual fund schemes are usually associated with negative returns, even if for a short time. But, truth is that debt MFs too can clock negative returns. Yes, it happens. In the past 6-7 months, different events have unfurled in front of our eyes. Companies have defaulted on payments, some corporates are under huge debt burden, etc. If the mutual fund invested or invests in such companies, there will be an impact.
Let us understand more. The Net Asset Value (NAV) figure for a mutual fund is a numerical representation of the net value of the scheme. For instance, the NAV of a debt fund you have invested today is Rs 100. You bought units at Rs 100. If after 6 months, the net asset value is Rs 95, this means your investment fell by 5% in these 6 months. It is a loss. Many investors would not like to believe it, but losses can happen in debt MFs.
Debt funds, like any other fund category, hold instruments whose prices fluctuate daily. The prices are linked to markets. A debt fund will generate a loss on days when debt markets fall and pull down the value of the debt securities. If the NAV of the fund is lower than your investment NAV, you are technically at a loss. But, you do not actually post a loss unless you exit/sell. Without selling or exiting the fund, the loss is technical in nature, at least for now.
In some cases, when the credit rating of an instrument that the fund holds is downgraded, the drop in their prices is evident. Some fund houses also take precautionary measures like writing down the exposure, which can result in drop in the NAV. At present, some debt funds are showing negative returns for 6 months to 1-year time frame. If the NAV of the fund recovers, the loss will be recovered too. Do not get scared if your debt fund clocks notional loss or negative return. Try to understand why it happened and whether there is any chance to recover.