Shift balance of debt funds in favour of higher credit-quality portfolios

Steps to improve liquidity may mitigate credit risk. Nonetheless, avoid lower-rated portfolios

In the second bi-monthly monetary policy for 2019-20, the Reserve Bank of India (RBI) cut the repo rate from 6 per cent to 5.75 per cent. This was its third consecutive rate cut. The central bank also changed its policy stance from neutral to accommodative. All this is good news for debt fund investors whose investments have taken several knocks in recent months due to a series of credit defaults and downgrades.

Several factors prompted the repo rate cut. “Both GDP growth and industrial production numbers have been weak. Other indicators of growth have also softened over the past two quarters. Moreover, inflation continues to be, and is expected to remain, below the RBI’s target level of 4 per cent,” says R Sivakumar, head of fixed income, Axis Mutual Fund. With inflation under control, the RBI’s mandate allows it to take steps to boost growth. Globally, too, yields have dropped sharply due to worries about the US-China trade war, and economic slowdown in a large part of the developed world.

The significance of the change in policy stance is that rate hikes are off the table for the near term. From here onward, the policy choice will only be between a pause and a cut. “It is a signal that the RBI expects rates to go down over a period of time,” says Sivakumar.

As for further rate cuts, Saurabh Bhatia, head, fixed income, DSP Investment Managers, says: “We expect one more rate cut to happen in the later part of this year. Then we will have to see how inflation expectations pan out.” Another factor that will determine further rate cuts is the Budget in July, when the course that fiscal policy will take will become apparent. “If the fiscal policy turns accommodative, the RBI may not cut more than once,” says Sivakumar.

Experts say the bulk of a retail investor’s money should remain in shorter-duration debt funds (liquid, money market funds, going in terms of duration only up to short-duration debt funds of up to three years’ average duration). “Long-term government securities have done well in the near past and will probably do well in the near future also. But on a structural basis, shorter-term corporate bonds will outperform,” says Sivakumar. Bhatia too believes that shorter-term funds remain the preferred option for retail investors. “A large part of the rate cuts has already played out. More importantly, shorter-term funds will benefit from the improvement in liquidity,” he says.

Medium- and longer-term bond funds should be avoided. “Most retail investors want safety in their debt funds. They should avoid longer-duration funds where volatility can be as high as in equities,” says Ankur Kapur, head, investment advisory, Banyan Capital Advisors. In the light of the recent credit-related troubles that debt funds have witnessed, investors should examine a fund’s portfolio closely before making an investment decision. Look at the rating mix within a fund. A substantial portion of the portfolio should be invested in triple-A and double-A rated securities. Second, watch out for concentration risk. While the regulatory limit for investing in a single issuer’s bonds is 10 per cent, ideally the exposure to a single issuer should be below 5 per cent or, better still, below 3 per cent.

In the past, many retail investors have invested in credit-oriented funds, lured by their higher yields. Bhatia says that with improving liquidity, the availability of money will improve, and this will take care of a lot of credit-related problems we are witnessing at present. Nonetheless, investors need to shift the balance of their debt-fund investments in favour of higher credit-quality portfolios.