How safe are debt schemes of mutual funds in India?

Both the RBI and SEBI have boosted oversight of the rules, which increases investor comfort

For investors looking to invest in debt schemes of mutual funds, the question uppermost in their minds is about the safety of their investments. This concern is all the more relevant if the investor is migrating or switching his/her investments from the traditional fixed income savings mode of bank FDs to debt mutual funds.

Bank FDs seen as safe

For Indian investors, bank FDs have a high connotation of safety as banks are regulated by the RBI and in the case of PSU banks there is the perception that they enjoy “sovereign” backing and the government will not allow these banks to default on their deposit liabilities.

Besides, the returns from FDs are simple to understand as the rate is predetermined and fixed for the tenure of the FD.

In contrast, mutual funds, being a pass-through vehicle, entail MTM (Mark to market) risk through daily movement in NAV of debt schemes and scheme portfolios which carry interest rate and credit risk.

So, naturally, the question arises, how safe are investments in debt schemes? Safety can have different meanings.

This article seeks to answer it from a more macro perspective — i.e. how safe are the investments made by debt fund managers?

Because, after all, what matters is the underlying portfolio of the debt scheme — the NAV and performance is a derivative of the same (after accounting for expenses, of course).

Regulatory oversight

Debt fund managers primarily invest in four broad asset classes: government securities (G-Secs), SDLs (State Development Loans), corporate debt and money market instruments.

While mutual funds are relatively in the minority when it comes to ownership of government securities and SDLs (banks are the largest investors here), the share of mutual funds is definitely increasing in corporate debt investments.

In money market instruments, mutual funds are the dominant investors.

Asset classes like G-Secs, SDLs and money market are regulated by the RBI and the Corporate Bonds market is regulated by SEBI.

Credit rating agencies (CRAs), that rate corporate debt, are also regulated by SEBI.

The importance of regulatory oversight hence, cannot be underestimated.

In this regard, investors can derive comfort from the knowledge that both these regulators have been very proactive in tightening regulations for not only mutual funds but also issuers and credit rating agencies, over the years, based on evolving market conditions. For debt mutual funds, some of the noteworthy regulations are in the area of sector exposure and single issuer exposure by SEBI.

Credit rating tightened

Last year, SEBI released a circular covering significant changes in four key areas — Standardisation of press release for rating actions, Disclosure of ratings in case of non-acceptance by an issuer, Disclosure in case of delay in periodic review of ratings and Policy in respect of non-co-operation by the issuer.

This year, in June, SEBI again released guidelines for rating agencies and debenture trustees to tighten the credit rating process in key areas like surveillance mechanism for identifying potential defaults, material events requiring a review, and, most significantly, to ensure issuers submit a ‘No default statement’ to CRAs on a monthly basis.

Similarly, in August this year, the RBI released guidelines on issuance of Commercial Paper that included more stringent rating requirements and also directed IPAs (Issuing and Paying Agents) to ensure verification and reporting of CP issuances in several key aspects.

The stricter regulatory guidelines ensure less risk for all classes of investors in the debt market, including mutual funds. This, in turn, is a source of comfort for mutual fund investors in debt schemes.

The writer is Head – Fixed Income, Principal Mutual Fund

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