Credit Defaults – Who is at Fault?

By now, you must have read many articles on this. And by any chance if you are reading this line, deep inside your mind, this feeling of `Oh No- Not Again’ would have popped up. Let us assure you – this is not #metoo.

Fixed Income (Markets & Mutual Funds) has been in the news again, for wrong reasons. But before we get there, let’s have some context.

Fixed Income was always perceived to be complex & complicated, by Financial Advisors. Our approach to Fixed Income Investment was different. We had (still have) a Top-Down Investment Philosophy that gels well especially in Fixed Income Portfolios. So, our focus was mostly to be on the right fund categories by drawing cues from the macros. And we run the Credit & Duration strategies based on the Macros as well as the Portfolio Risk Mandate.

Sounds good conceptually? But was not that good, practically.

Because, ultimately we have to execute these strategies through specific funds. And the AMCs were notorious in creating complexity by having multiple funds that runs similar, yet ambiguous mandates. Not to mention the misleading scheme names they had. Choosing the right fund warranted for scrutinizing the fund’s investment history and keeping the fingers crossed that AMC would stick to it.

SEBI cleaned up the mess by scheme rationalization exercise. One scheme per category & that too with a clear investment mandate. It was a much needed reform & as a regulator SEBI has been phenomenal on Mutual Funds. A common benchmark per category also would have been ideal in order to bring in uniformity for ratio computations & performance comparisons. We will wait for it-:)

Back to the Title & Connecting the Dots

SEBI introduced Credit Risk – A new fund category in which investors who are yield savvy can participate by compromising on the credit quality. The investment mandate - 65% of total assets are to be deployed in below highest rated instruments.

Great, now the Advisors & Investors clearly know the kind of risk they are taking. As of 31st August 2018, the stats for Credit Risk Funds stood as follows

So, as mentioned above, if the Advisor is recommending & Investor is buying a Credit Risk Fund, the risks associated with it are fully appreciated. But, how about other categories? Are we sufficiently informed about the credit risks in those? Let’s take a look

*In Crs

If you were to make a judgment basis the data above, how on earth would you make a good credit risk assessment, as most of the exposures are already in AAA segment. This is exactly where the problem lies.

We go by Ratings. Ratings given by Agencies who are supposed to assess the credit worthiness at a security level. We dug deep & examined the fixed income security universe held by MFs & the ratings associated with it.

There are about 4759 fixed income securities held by MFs. To put it in perspective, the number of stocks held by MFs stands at just about 1069. Notwithstanding the fact the issuers of these fixed income papers will be far lesser.

Voila! It’s just about 7% of the universe is in the `A’ segment.

Rest all is Cool! Cool until things get Hot--:(

In 2018, approximately 31 papers got upgraded 9 issuers, while just 1 paper got downgraded. The downgraded paper was of a Bank that gotten itself into a controversy/scam.

We also looked at the data from a Sector point of view. Majority of the exposures have been with 10 sectors. Given below are the most prominent ones.


For a vibrant Fixed Income Market, credit rating processes must be robust, regular & dynamic. While SEBI has made stringent accountability & fiduciary for Advisors, it is high time that they make other stakeholders accountable too. The irony is, it the same agencies that provide reference yields and does the fixed income valuation for AMCs. Credit Rating, in its strictest sense is fundamental/bottom up research & if the AMCs internal research processes are robust, they should pay less care to ratings and focus more on Advisor Communication on the Portfolio Quality of their funds.

Most of the Advisors resort to Accrual/Coupon as the return mode as opposed to Duration/Trading Gains & hence it is critical that their decisions are supported with diligent processes that reflect the Yield in the most accurate manner. Though we acknowledge the risks associated with Fixed Income, the reality is, an Investor is not prepared (mentally) to absorb a loss in a Debt MF. And the hard fact is, the loss in a Debt Fund takes a much longer time to recoup.

If these issues are not addressed, it would not be long that the Industry Efforts turns futile and Investor Sentiments turns out to be #MutualFundsSahiNahiHain

Disclaimer: This communication is only meant for qualified and certified Financial Advisors. This document should not be construed as an invitation/recommendation to purchase or sell a security or take any position in the market. All data presented are as on 31st August 2018. We have used internal & external sources to compile & analyze the data. While we have taken utmost care to ensure accuracy, Pulse Labs bears no liability & responsibility whatsoever, on the data & the decisions taken based on this article.

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