After the recent Franklin Templeton episode, investors are wary of credit risks. However, as mutual funds are more exposed to structured credit, they are still safe, Amit Tripathi, CIO, Fixed Income Investments, Nippon India MF tells ET Wealth.
With credit profile of India Inc set to sag further, do you see more pain for debt funds?
The post-Covid environment will only add to the weakness that existed even before the lockdown. There are two aspects to this weakness—availability of liquidity for corporate balance sheets and debt servicing capability of India Inc amid slow growth. In the midst of this, the Franklin Templeton episode has turned the focus on concerns around credit.
Going forward, the environment will be even less sanguine. One will have to be careful for the next six months. Credit quality deterioration will be more pronounced in the unsecured space. Among non-financials, discretionary consumer facing businesses will face issues. These businesses will need sufficient capital buffers to survive.
Structured credit will continue to outperform plain vanilla credit. Mutual funds are more exposed to the former, and hence in better shape. While the incremental risk definitely exists in the current environment, I don’t see any names coming under pressure immediately.
Some of your debt funds have seen sizeable redemptions. How are you tackling the situation?
Redemptions were very high in the recent past. But we are more comfortably placed now. Even in some of the lower rated exposures, we have seen refinancing and cash flows through buybacks and prepayments. This allowed us to create liquidity outside the normal secondary market route. Infrastructure debt funds, FPIs have also come in to take advantage of the attractive yields. Through a combination of working with issuers for prepayments and by selling some exposures we have been able to generate sufficient liquidity even in credit funds.
With the spotlight on credit risk funds, how do you plan to maneuver Nippon India Credit Risk through the stress?
There are things we will do differently. In credit funds, we will focus only on those names where cash flow visibility is very high and structures are self-liquidating in nature, particularly in high yield bonds. This way, we won’t be at the mercy of balance sheet vagaries nor have to rely on refinancing.
We will also focus on avoiding concentration risk—something we have suffered from both in terms of illiquidity and bigger impact from a credit event. The overall composition of the portfolio will have to undergo a change, maintaining reasonable allocation to high grade bonds to manage liquidity. We have also taken a decision not to invest below AA rated corporates across schemes other than credit risk funds. The size of the liquidity problem is not very significant now as a percentage of the total debt AUM— less than 5%. This is a viable category in the medium to long term, and will be back in the reckoning sooner than later.
Why did Nippon India Strategic Debt & Nippon India Ultra Short Duration explore low quality credits?
Nippon India Strategic Debt has never invested in any instrument with lower than AA- rating. Even the AA- component was fairly low. What happened is that 2-3 of our large exposures, which became larger as percentage of the portfolio when the scheme sizes reduced, saw significant deterioration in credit post-purchase. While they were AAA or AA rated at the time of purchase, they saw multiple rating downgrades subsequently. That is why the optics of the portfolio shows a different picture now.
Ultra Short invested in a mix of AAA, AA+ and AA-. However, there was a credit event in one of its holdings. The portfolio size after this event came down drastically. We were forced to sell many exposures. So because of a few credit events that were large in the context of the fund holdings, we saw significant redemptions which skewed our overall portfolio quality.
Are investors right to flock towards relative safety of liquid funds and Banking and PSU funds? Has long duration strategy run its course for now?
Both short and long term high-grade segments have delivered very good returns. However, long-term segment has the issue of visibility given the current fiscal uncertainty. While RBI has been cutting rates and providing liquidity, there are uncertainties on the medium term fiscal consolidation path. Hence, investors want to be in high grade short-end comprising liquid, ultra short term, corporate bond funds and Banking & PSU debt funds. Some flows have been seen in high grade long term duration funds as well.
Currently the absolute levels across the curve for sovereign /AAA assets are low, but the curve is very steep. We have moved to a low growth /low inflation environment from medium to long term perspective. Hence, long duration makes more sense with a 3-5 year perspective. From a 3-12 month perspective, interim volatility can be very high, hence investors should stick to the shorter end. Overall, a 70:30 allocation where 70% goes into short term high-grade and the rest in long term high-grade could be a good strategy.
Do you think the current categorisation of debt funds is flawed?
If you add up all the credit events over the past 12-18 months, 80% of the papers would have started off AAA rated. But at the same time, it would not hurt to give investors some confidence at this time. Anything with higher AAA, AA exposure gives more confidence. Adding credit range along with duration risk might be workable and beneficial for investors.
We should not extrapolate the event of the last 12 months. On our part, we will learn from our mistakes, and ensure the negative surprises in debt funds are reduced to near zero levels.
