Debt funds could become the next big crisis if ignored now
For a long time, debt funds were treated as the gold standard in mutual fund investing. Limited risk and assured returns made them a natural choice. In the last few months, IL&FS and DHFL have changed the narrative. It is time to rectify the crisis urgently before it becomes a case of trust on trial.
How debt fund took a hit
For a long time, the credit opportunities funds were treated like bond funds with an edge. The problem started when IL&FS defaulted and got exacerbated with the latest DHFL interest default. When bonds of private entities are downgraded, there is a huge write-down that fund need to take and the investors are the ones to take the NAV loss. With the recent delay in FMPs due to Essel exposure, debt funds are truly on trial.
A systemic risk too
What we saw in the case of IL&FS, Essel Group and DHFL is not just a case of losses for investors but also a cascading effect. When NBFCs default, the sectors like automobiles and realty funded by these NBFCs also are pushed to the brink of default. The impact, thus, is a cascading one. The 3 cases have actually resulted in yields on private debt paper moving up and that is pushing up borrowing costs. This also creates a solvency risk for companies which are already vulnerable due to the crisis in the overall NBFC segment.
Quest for higher yields
To a large extent the fund managers have only themselves to blame for this state of affairs. As competition increased among funds to woo debt fund money, private debt came as an easy answer. Yields were at least 100-150 bps higher than the normal G-Secs and that gave a huge boost to the returns that these funds could offer. This in turn attracted more flows. Nearly 20% of all debt fund money is invested in private sector debt and that could be a real challenge if the problems worsen. Also, there have been a large number of cases where MFs have virtually funded the promoters through debt funds and Essel is the most glaring example. The quest for higher yields has come at a steep cost.
Time to act is now
The bigger takeaway is that SEBI has to act urgently. Let all debt funds make a transparent and audited disclosure of their portfolio values and make adequate provisions. Funds must be forced to offer an exit to MF investors without exit load (not the UTI style). It is the time to probe deeper and make mutual funds accountable where the fall in NAV is due to imprudent decisions. It is time to make the fund managers more accountable, like bankers are held accountable in case of bad loans. SEBI must also ring-fence the good portfolio of debt funds. Above all, it is time to act fast to sustain retail trust in MFs!
