If you are an investor in debt mutual funds, do keep an eye on the size of your fund scheme. It is a red flag if the size of your debt fund scheme has gone down sharply. If your fund scheme has experienced sharp outflows, you need to investigate.
What is the problem if the size of my debt fund scheme has gone down sharply?
If your fund scheme is experiencing fund outflows, you need to dig deeper. The quality of your fund portfolio may deteriorate if the size is going down sharply. In any case, the smaller fund schemes are likely to have higher concentration risk.
Let’s say your fund scheme is Rs 10,000 crores. Over the next few months, the fund size falls to Rs 1,000 crores.
What are the implications?
To meet redemption pressure, the fund manager will have to sell bonds from the portfolio. Good quality bonds are easier to sell. If the fund manager must sell good quality bonds to meet redemptions, the remaining investors may be left with a portfolio with a much higher concentration of not-so-good bonds. For instance, Rs 10,000 fund has Rs 100 crore exposure to a company that is under stress. 1% of the portfolio. Manageable. Perhaps, you can live with this kind of risk.
If the fund size goes down to Rs 1,000 crores and the scheme still has Rs 100 crores exposure to the company under stress, the exposure is 10%. Now, this is a serious problem. This is exactly what happened with some of the funds that showed very sharp losses after DHFL default. Even though the exposure was manageable when the problem first surfaced, the exposure got concentrated as the redemptions pressure rose.
Please understand this may not necessarily happen. It is very much possible that the quality of the portfolio is still very good after the redemptions. However, we also need to appreciate, if everything was fine, why will so many investors (or the big investors) leave the fund? securities. Additionally, you must note that there may be fluctuations in the size of the debt fund schemes in the months of March, June, September, and December when advance tax payments are made.
Persistent outflows from your scheme could mean that there is something wrong with your fund scheme portfolio. You need to dig deeper.
Point to Note
In my opinion, retail money is sticky (does not go out quickly). On the other hand, HNIs and corporate treasuries will take out their money overnight. They are better informed too. Therefore, it is possible that your fund has problems, but it does not reflect in the fund size (if the retail investors are the major investors in the scheme). This can happen in case of popular debt mutual fund schemes.
Side-pocketing won’t help beyond a point
The concept of Side-pocketing was introduced by SEBI in 2018 to prevent retail investors from being short-changed in debt mutual funds. While the side-pocketing is good in principle, it can only prevent the damage after the default has happened. The flight of capital from the fund may happen much before the credit event actually happens. If you are an existing investor despite a massive outflow, your portfolio may have a higher concentration risk. Therefore, you need to be vigilant about the fund size.
How to keep a track of the debt mutual fund size?
There are many ways to do this.
#1 The mutual fund companies (AMCs) are required to disclosure scheme-wise portfolios every month. The AMCs must also send e-mails to the investors about these portfolio disclosures. You will get e-mails such as the one below between 7th and 10th of each month. The portfolio is as on the last day of the previous month. Therefore, the e-mail that you get on September 8th will have portfolio composition as on August 31.
You need to go to the link. You can download the file and check the size of the fund scheme you have invested. In that excel, you can also check the complete portfolio of the scheme. Therefore, if you have been hearing bad news about a company and want to check if your scheme holds any bonds from the company and the level of the exposure to such bonds, you can check this in that excel file.
Please note the portfolio disclosures are available in the public domain only on a monthly basis. Therefore, even on September 29th, the latest publicly available data will be as on August 31 (unless the AMC chooses to communicate separately to the investors).
By the way, the aforesaid excel file contains details about the equity schemes too. However, equity schemes are difficult to gauge just by looking at the portfolio. After all, a bad company may make for a good investment if the valuations are good. Alternatively, a good company can make for a bad investment at rich valuations.
#2 There is another much easier way to check the scheme size, especially that’s the only thing you want to check. You simply have to go to ValueReasearch website and search for your scheme. At the very top, you will find something like this.
You can check this, say, once every quarter during normal times and on a monthly basis if you know that your scheme holds a troubled security. If you go the “Download Reports” section and download the fund card, it also shows the annual trend of fund size. However, you may want to check at a higher frequency if you are aware that your fund scheme has exposure to a troubled entity.
#3 The quickest way is to go to the AMFI website. On the AMFI website, you can check the data even on a daily basis. The above two methods don’t provide data on a daily basis. Thanks Pradeep for pointing this to me in the comments section!!!
I haven’t kept track of the portfolio size in the previous months or quarters
In the portfolio disclosure link (that you get in mails), you can access portfolio data for the previous months too. You can check the trend in fund size by looking at the sizes for the past few months or quarters. You can also compare current data with the data prior to the month when the issue with the troubled entity first surfaced.
What should you do if the size of the fund scheme has fallen sharply?
The sharp fall in fund size is clearly a red flag.
Try to understand to root cause. It could be due to some issues in the fund portfolio or it could due to aversion to a fund house or category. The first reason is a big problem. The second is not as much. An example of the second reason, after the spate of defaults recently, the bigger fund houses have gained at the expense of the smaller fund houses. Or a move away from long-duration bond funds when interest rate hikes are expected.
Here is what you should do (especially if the portfolio has issues i.e. higher concentration of troubled securities) :
- Stop making further investments in such schemes
- About the existing investments, you need to choose between the following.
- Exit the fund and pay taxes. If your debt fund investment is over 3 years old, taxes won’t be much of a problem. OR
- Be aware of the risk. Track the size and the level of exposure to the troubled group or entity on a regular basis, perhaps even monthly.
Between paying taxes and living with the risk, you must make a choice. If you sell before 3 years, you will have to pay STCG at your slab rate. If you sell after 3 years, your capital gains will be taxed at 20% after indexation. Contrast this with the percentage exposure of your scheme to the troubled entity.
A lot would depend on the quantum of your investment in the fund, vintage of your investment and your tax slab rate.
Equity mutual funds don’t have an alternative. Debt mutual funds do
As retail investors, there is nothing that would give offer us the risk-return profile of equity mutual funds or ETFs. I assume we are not good at picking stocks.
However, in the case of debt mutual funds, there are clear alternatives. You have bank fixed deposits, small saving schemes (PPF, SY etc), Government bonds, annuities, etc. Debt mutual funds are clearly the riskiest lot. Therefore, before you invest in debt mutual funds, you need to see if debt mutual fund investments make sense for you.
In short, debt mutual funds score over bank fixed deposits in the flexibility in redemption, tax efficiency and scope of higher returns by taking credit and interest rate risk. At the same time, debt funds exhibit greater volatility and greater risk.
You need to see what is right for you. Remember, unlike equity investments, the upside of debt funds is relatively capped. For instance, if you are a senior citizen and fall in 0% or 5% tax bracket, there is limited incentive for you to invest in debt mutual funds, especially the debt fund categories that I like. Or if you are an NRI, you have this option of investing in NRE fixed deposits, where the interest income is exempt from tax, at least in India.
Here is what I focus on while choosing debt funds for my or my clients’ portfolios.
- Low Interest Rate Risk (overnight funds, liquid funds, ultra-short duration, low duration, money market funds)
- Low Credit risk (appreciate the risk if you choose to invest in funds that take greater credit risk)
- Low Expense ratio (track this too on a regular basis. Your AMC may be taking you for a ride)
- Bigger fund house
- Bigger fund scheme
I have discussed the checklist in detail in this post.
With investments, no matter how diligent you are, you may still have to make a course correction.
Select the right investment product. Look out for red flags. Assess the risks and costs. Make course correction.
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