Even since Franklin AMC wound up its 6 schemes, the credit risk funds have been facing very heavy redemption pressures.
I copy the Assets under Management for Credit Risk funds for various dates.
December 31, 2019: Rs. 62,704 crores
March 31, 2020: Rs 55,380 crores
April 23, 2020: Rs. 48,576 crores (the day Franklin wound up its 6 schemes)
April 30, 2020: Rs. 35,222 crores
May 20, 2020: Rs. 30,917 crores
You can see that the category has lost over half its assets since the beginning of the year. It has lost about Rs 25,000 crores since the end of March. Now, credit risk funds and Indian bond markets have a peculiar problem. By definition, the credit risk funds must invest at least 65% of its assets in bonds rated AA or below (SEBI has relaxed this threshold for 3 months to 50%). And these bonds are not easy to sell. Quite clearly, the credit risk funds are not equipped to handle such massive redemptions.
Hence, it is possible that to fund these redemptions, the AMC might transfer/sell these bonds to another scheme within the AMC and get the funds to meet redemptions. This is called inter-scheme transfer.
Inter-scheme transfer of corporate bonds is not illegal. It is not a new phenomenon either. It happens all the time between various schemes of the AMC. SEBI website has data on inter-scheme transfer of corporate bonds since August 2009. However, the SEBI provides data only on the aggregate industry level, and not at AMC or scheme level. All SEBI wants to ensure is that these transactions happen at fair valuations.
As I understand, such transfers must be quite common within debt mutual fund schemes. However, it has been pointed out that, during the month of April, some of these corporate bonds were transferred from credit risk fund to the hybrid funds of the AMC. Now, this can be problem for investors in such hybrid schemes.
Did you sign up for the credit risk in your hybrid funds?
A quick look at the AMCs that have done this. Compiling this information is a lot of work. I have specified at the end of the post how you can compile this information on your own. Fortunately, for me, a fellow blogger had done the work for his post and gave me permission to use the data.
Here is the link to the article from where this data is sourced.
Why will the AMCs do this?
The credit risk funds faced heavy redemption pressure in the month of April, especially after Franklin wound up its 6 schemes. By transferring a lower rated corporate bond to a hybrid fund, the AMC achieves the following:
- The bond does not have to be sold at beaten down valuations.
- The bond may be illiquid. The hybrid fund buys the bond and provides much needed liquidity to the credit risk fund to meet the redemption.
- The AMC could have transferred the bond from credit risk to another debt mutual fund of the AMC. However, the new bond fund will have to pay the credit risk fund. And for that, some bond would have to sold in the market to create liquidity.
- On the other hand, the hybrid funds also have equity exposure. They can sell equity in their portfolio (if required) to generate funds to pay the credit risk fund. In India, equity markets are much more liquid as compared to bond markets. By the way, it is not necessary that certain investments must be sold. All the funds receive purchase requests (lumpsum, SIP) and redemption request. Hence, they may have cash surplus for the day. Alternatively, they may be sitting on cash already.
- These days, there is a heavy focus on the credit quality of the debt mutual fund portfolio. The credit risk fund could have very well sold AAA rated bond from its portfolio. However, the average credit quality of the portfolio would have gone down with the sale of AAA bond. Had the bond been sold to another debt fund, the other debt fund would have experienced the same thing. However, there is lesser focus on the credit quality of the fixed income portfolio of the hybrid funds. Hence, it can be good place to hide lower rated illiquid papers.
From the point of view of investors in these hybrid funds, this is a cause for concern. The interests of the AMC have taken precedence over investor interests (or so I can believe). The AMC can always justify the corporate bond transferred is a right fit with the portfolio of the hybrid fund. They have done nothing illegal either. However, in my opinion, not everything is right. Such inter-scheme transfer of corporate bonds may be right to the letter of the law, but it is not right in spirit.
What should you do if you have invested in these hybrid funds?
I have written about credit risk in fixed income portfolio of hybrid funds. Most investors tend to ignore this (I am not much different).
As an investor, you must keep an eye on the fixed income portfolios of your hybrid schemes, just as you must do for debt mutual funds. The AMCs are required to disclose monthly portfolios. You also get an e-mail with the link to the portfolio page. All you have to do is to download and take a quick look. AAA, SOV, and A1 exposure is fine. Lower the AA rated and below exposure, the better it is. With the AA-rated space, I am comfortable with exposure to banks (but that’s my opinion). A high AA and below exposure to non-banks can be a source of concern and you might want to dig deeper.
About this recent episode of transfer of lower-rated corporate bonds from credit risk funds to hybrid funds, there is a need to be alert about the fixed income portfolio of your hybrid fund. You need to monitor the portfolios. If you are not comfortable with the credit risk in the fixed-income portfolio of the hybrid fund, you can exit the fund. At the same time, there is no need to panic or be paranoid. AA rating does not mean that the default is imminent.
How do you find out about inter-scheme transfers?
For the detailed information about inter-scheme transfers, you must go to either to AMC website or the AMFI website. The trade data (including inter-scheme transfers) is available with a 30-day lag. On the AMC website, you must go to Statutory Disclosures->Disclosure of transactions in debt and money market securities. I provide the links for HDFC MF and ICICI Prudential MF. However, it is a lot of work to decipher all the data. The data is for daily trades. Hence, you may have to compile for the entire month. Subsequently, it does not even specify who bought and who sold. For instance, Scheme A may have sold Bond X to Scheme B. However, the file only shows that Schemes A and B transacted in Bond X. You have look at monthly portfolios to figure who actually bought and sold. Quite a mess.