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Be prepared for lower returns from your debt mutual funds

A host of measures taken by the Securities and Exchange Board of India (Sebi) to enhance the safety of debt mutual funds are likely to drag down the returns from these schemes, say mutual fund advisors.

, ET Online|
Updated: Nov 13, 2019, 11.36 AM IST
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A host of measures taken by the Securities and Exchange Board of India (Sebi) to enhance the safety of debt mutual funds are likely to drag down the returns from these schemes, say mutual fund advisors. According to these advisors, debt mutual fund managers are likely to try hard to avoid unnecessary risk and the flight to safety might result in lower returns from debt mutual fund schemes.

The market watchdog has come up with a slew of measures after the debt mutual fund universe was hit by a series of defaults and downgrades, starting with IL&FS fiasco. Earlier, Sebi made early redemptions from liquid funds more expensive with a graded exit load structure. The watchdog also defined some norms for debt mutual funds’ lending against shares to make the schemes safer for investors. Sebi also made disclosures stricter for promoters’ share pledges. In the most recent circular, Sebi directed the mutual fund houses to inform valuation agencies and credit rating agencies about any changes in terms of investments in their debt or money market funds.

Puneet Oberoi, Founder, Excellent Investment Advisors, says Sebi wants to ensure that no debt mutual fund category other than credit risk funds takes unnecessary risk. "But this can lead to lower returns and lower inflow into the debt mutual fund schemes. Investors will have to choose one among safety and extra returns in the coming time," he says.

"Most of the AMCs -big and small, excluding a few like Franklin Templeton - have their portfolios full of just AAA-rated papers and securities. They are taking zero bets on even AA-rated papers. A fund manager's job is to manage schemes, not to just sit in the highest rated ones. How will you make money in the scheme if you don't take calls and keep buying expensive securities," asks a mutual fund advisor, who does not want to be named.

"Most short-term schemes are not making money. Yields are low and fund houses don't want to take risk. I think we are staring at a time when debt mutual funds will be safer, but will not make extra returns," says Chokkalingam Palaniappan, Founder, Prakala Wealth Management, a Chennai-based wealth management firm.

Chokkalingam says mutual funds are in a good position at this point of time because the past one-year data is in their favour.

"Investors generally bet on after looking at the past performance. We will have to see how these schemes fare with a portfolio of just AAA-rated securities. There is competition from RBI bonds, Senior Citizens Saving Schemes, Sukanya Samridhi Yojna. Bank FDs which are giving around 7% rate of interest these days, ironically they bet on lower-rated papers," adds Chokkalingam.

Debt fund category 1-year return (in %)
Long Duration 15.66
Medium to Long Duration 8.77
Medium Duration 5.50
Short Duration 5.77
Low Duration 3.15
Ultra Short Duration 6.98
Liquid 6.70
Money Market 8.19
Overnight 5.68
Dynamic Bond 8.87
Corporate Bond 6.62
Credit Risk 1.16
Banking and PSU 10.73
Gilt 12.65

Puneet Oberoi says the intense Sebi scruitny has resulted in the AMCs started becoming cautious about the risk they take in debt mutual funds. "Post the IL&FS default, the way debt funds are managed has changed drastically," says Oberoi, who adds that this has been prompted by the reaction of mutual fund investors advisors after the recent debacles faced by many debt mutual fund schemes.

"Mutual fund advisors like us asked investors to not to bet on schemes that are run with extra risk and investors followed our advice. Now, we are seeing that many mutual fund houses are building their portfolios with the safest papers. So, there is no place for an investor who wants to take extra risk to earn extra returns," says Oberoi.

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