Targeted liquidity for NBFCs, MFs to ease systemic stress, says R Sivakumar

The outflows seen in March are a quarterly and annual phenomenon whereby some institutional and corporate investors redeem and re-invest at the start of the new quarter/year, says Sivakumar

The chase for yield needs to be balanced with an understanding of risk, says R Sivakumar, head - fixed income, Axis AMC. In an interview with Ashley Coutinho, he says the RBI's new liquidity facility has calmed the market and has reduced investor anxiety regarding liquidity in some of the funds. Edited excerpts: 

Many debt fund investors have rushed to redeem their investments in the past few weeks. Debt funds saw one of the highest-ever outflow of Rs 1.94 trillion in March. Is the redemption pressure primarily restricted to institutional investors or is it widespread across the board? 

The outflows seen in March are a quarterly and annual phenomenon whereby some institutional and corporate investors redeem and re-invest at the start of the new quarter/year. This phenomenon has been repeated this year also and currently we see that many of the same funds (liquid funds) that saw the largest outflows have regained their AUM in the new financial year. Certain categories such as credit risk funds have seen outflows over the past year and continue to see outflows now.

Are you satisfied with the measures taken by the RBI to ease liquidity in the system? A section of market players believe that the measures may not be enough to resolve concerns with regard to credit risk schemes. Your thoughts on the same. 

The RBI’s special liquidity facility for mutual funds is a large programme up to Rs 50,000 crore in size. This is larger than the total credit risk fund assets. That is to say it is possible to get the entire liquidity needs of credit risk funds financed by this new facility. The fact that RBI is willing to provide this liquidity facility has calmed the market and has reduced investor nervousness regarding liquidity in these funds. 

How are large corporates/treasuries dealing with the situation?

Larger investors such as institutional and corporate investors typically invest in AAA-oriented funds. These funds are highly liquid as the market for sovereign and AAA-rated bonds are quite liquid. The challenge in debt markets is the relative illiquidity of lower rated debt especially those below AA. These bonds constitute a small minority of mutual fund assets and therefore we have not seen much pressure in terms of liquidity across the industry. We continue to see net inflows especially from corporate clients in the current environment in liquid and other high quality oriented debt funds.

The current categorisation norms allow funds to take credit risk even in shorter tenure funds.  Ten of the 16 debt categories define funds based on duration alone, with no mention of the kind of credit risk they can take. Is there a need to revisit the norms in the light of the current crisis? 

The categorisation of funds provides investors with some key differentiators across different fund categories. Within that flexibility is provided to funds to invest across duration and credit strategies. It is important to see the funds’ portfolios before making investment decisions as the categories are only one way to filter the scheme choices available. The advantage that MFs offer is that they are fully transparent with respect to the portfolio. Thus in addition to the basic metrics such as track record and yield to maturity, it is very easy to look up the risk of the fund based on its credit profile.

Mutual funds have been cutting debt exposure to NBFCs/HFCs (down approximately 45% from the peak in July-Aug 2018) with even sharper cuts (down around 90%) to entities in real estate financing, promoter financing etc, which are down to around 1.5% of mutual fund debt AUM. How has that helped?

Over the past year and a half, MFs have been reducing exposure to perceived higher risk sectors. This has been due to the impact of IL&FS failure back in 2018 and the broader economic slowdown in 2019. The result is that the share of these higher risk sectors has reduced. Investors too have chosen to invest in funds that are largely deployed in AAA or equivalent bonds rather than higher yielding instruments. The combination of these two trends has resulted in the industry’s allocation to riskier debt decreasing materially. This correspondingly means that the overall credit profile of MFs has improved over the recent past.

Could you tell us about some of the learnings post the IL&FS episode for debt mutual funds? How is the 2008 situation --- a period when debt funds struggled as well --- different from what we are seeing today?

The chase for yield needs to be balanced with an understanding of risk. Especially in non-AAA instruments, risk comes in two forms – credit and liquidity. They are inter-linked as lower rated bonds have lower liquidity too. It becomes imperative that when we build fund portfolios we size the positions according to the risk -- smaller investments to lower rated companies and groups. At Axis, we have been following a process of scaling investment limits based on rating since the inception of the fund house.  This also helps handling external shocks such as the current Covid-19 situation and the attendant loss of liquidity in markets. The shock to the market is not too different as compared to 2008 or 2013. For example, AAA yields rose by 100-200 basis points in those times too. However, this time around the RBI has been proactive in adding liquidity and cutting rates. This has had the effect of reducing the stress in most parts of the yield curve. The additional interventions such as the targeted liquidity facilities for NBFCs and MFs should also ease the stress across the financial system.

What are the parameters that investors should look at while assessing debt funds, especially in the current situation? What is your advice to them? 

When analysing debt funds it is important to look at the returns and risk profile of the fund. Returns are easy to understand and are easily available to see. When it comes to risk the key risks are interest rate and credit risks. Interest rate risk can be observed via the duration of the fund. Credit risk through the credit profile (allocation to AAA/AA/A rated securities). One important point to be kept in mind is that AAA bonds are more liquid and are more frequently traded. This gives an impression of greater volatility. The volatility of credits can be masked by the low liquidity. We must remember that a bond of, say, three years’ duration will have similar interest rate risk irrespective of its credit rating. It is just that the daily volatility could be different. In the current Covid-19 related uncertain business environment, investors should consider investing in short to medium term funds investing primarily in AAA and equivalent securities.