Recategorisation of debt funds: Keep a close eye on your scheme's portfolio

While funds will stick to their stipulated duration band after categorisation norms kick in, they may take credit risk, which investors should watch out for

While the impact of recategorisation on equity schemes has been much discussed, debt and hybrid funds have not received as much attention. But these schemes have also seen considerable impact. Investors should first understand the change that has happened in their funds and only then decide whether to stay in the fund whose category has been changed, or move to another one.  

Among debt funds, a large number of categories,16, have been created. Among low duration, you only had liquid funds earlier, which invested in papers having a maturity of up to 91 days. But now a few new categories have been introduced, such as overnight funds. These funds will invest in papers having a maturity of one day only. "This category is meant more for institutional investors and retail investor can give it a miss," says Kaustubh Belapurkar, director-manager research, Morningstar Investment Adviser India. Another low-duration category that has been introduced is that of money market funds, which will invest in certificates of deposit and commercial paper.

The way income funds were managed is set to change. Now these funds will have to operate within a fixed duration band. Medium duration funds will have an average portfolio duration of three-four years, while medium to long duration funds will have a duration of four-seven years. "In a rising interest rate scenario, if the fund manager wants to reduce his duration, he will have to take special permission from his board," says Belapurkar. Similarly, longer duration funds, which are supposed to maintain an average portfolio duration of more than seven years, too will have to stick to their mandate. In a rising interest rate scenario, these funds could suffer erosion in their net asset value (NAV). Retail investors should be aware of the higher risk in these funds before venturing into them.

One category that investors should watch closely is corporate bond funds. Here, at least 80 per cent of the portfolio must be invested in double-A plus papers. Funds moving into this category could see considerable changes in their strategies. "A credit opportunity fund moving into this category will have to bring down its credit risk. Similarly, a dynamic bond fund moving into this category will have to stop taking duration risk and move to an accrual strategy," says Bhavana Acharya, deputy head-mutual fund research, FundsIndia.com.

According to experts, the issue of understanding the nature of debt funds will remain. Take the example of short-term funds. Earlier, you had funds within this category that took some credit risk, and you also had others that did not take any credit risk. That issue will still persist. "Just because Sebi has said that short-duration funds should have an average portfolio duration of one-three years does not mean that these funds are not going to take credit risk. Investors will still have to keep a close eye on what their fund is doing in terms of credit risk, and should avoid investing just on the basis of past returns," says Acharya.

As far as the hybrid category goes, monthly income plans will now be called conservative hybrid funds, and will be allowed to take equity exposure of 10-25 per cent to equities. Another category called balanced hybrid funds has been created, which will have 40-60 per cent equity exposure. Experts say that this category may not find too many takers. Most of the earlier balanced funds would like to stay in the aggressive hybrid category, where the equity exposure is 65-80 per cent, as this will make them eligible for equity-like tax treatment.
 

Another key development is the creation of the dynamic asset allocation or balanced advantage category. This is akin to the multi-cap category within equity funds. It is the go-anywhere category within debt funds, where fund managers will be free to take any kind of exposure. HDFC Prudence, which was earlier a balanced fund, has been reclassified into this category.