Debt funds: A new negative

With debt funds losing up to 40-50 per cent of their values are now setting a new trend for the industry wherein funds now, will not only be bought on the basis of YTMs( Yield till maturity) but a deep study and analyses will come into practice henceforth.

Debt funds also known as fixed-income funds and are a profitable alternative to fixed deposits of banks, primarily on the basis of high returns and tax advantages because of lower long term capital gain tax on debt products. But, post the IL&FS default, things do not seem to be that rosy for debt funds. Thus, it has been a roller coaster ride for the investors as well as for the advisors too who always thought that investment advisory is more about equity investments and not fixed income.

There are three key reasons which I think have caused a widening trust deficit between investors and debt fund managers:

1. Credit rating agencies: Credit rating agencies in our country are more like a cop of a Bollywood movie which generally comes late. Similarly, our credit rating agencies react after the negative event has already taken place. The type of AAA ratings that these invigilators give clearly shows the nexus between agencies and the promoters of the companies.

2. Over-dependence on Credit rating agencies by Mutual funds: The lack of internal research and over-dependence on credit rating agencies has caused a major loss of faith in AMC’s. But still, I feel mutual fund as fiduciary, should spend more on research rather than on maintaining the high-class lifestyle of CEOs and sales staff. It’s their solid research and execution which will elevate them to the next level.

3. Lack of knowledge of advisors and wealth managers: Advisors and wealth management firms are paid for reading between the lines and choosing the right product for investors but lack of knowledge leads them to chase high yields and returns rather than managing risk along with returns.

I strongly stand by my research and all aforesaid reasons should be worked upon and only then, we can rebuild the confidence. Here, one more thing that we have to keep in our mind that none of what that has happened during this fall of debt NAVs is a black swan event and in case something like Lehman event happens, that can totally destroy confidence in this product which has a huge potential in a country like India.

In the next article, I will cover and discuss “How to choose a good debt fund”.