3 Early Warning Signs of a Bad Debt Fund – Is Your Debt Fund Safe?

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is your debt fund safe

Post Franklin Templeton fiasco the debt fund schemes have been in the focus for all the wrong reasons. It is really painful to witness that the risk perception in Debt (which had been traditionally less) has outgrown Equity in the recent past.

The debt fund Investors are in quandary and staring at decreasing numbers against their net worth.

We are so good at post mortem as we enjoy the hindsight benefit.

However, there is a dearth of good prognosis tool especially for checking the health of a debt scheme. If investors go with industry-wide rating done by various “independent” agencies then also the warning element cannot be ensured.

This is evident from the Analyst Rating of 5 funds of Franklin Templeton done by a reputed agency

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So I thought of developing a diagnostic tool to check the health check of debt fund schemes so that an investor can act in advance and save his portfolio from crashes & shocks

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 1. Creation of side pockets/segregated Fund in a Debt Fund

If a bond in the debt fund portfolio becomes noninvestment grade then the scheme can create a Segregated Account aka use ‘Side pocket’.

A ‘side pocket‘ option allows the scheme to separates its portfolio into (a) good portion, consisting of investment-grade bonds, and (b) bad portion ”Segregated Fund” comprising the downgraded bond.

An investor should be watchful of the schemes with segregated funds, as the returns from these schemes have been mostly negative as evident in the table below:

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                                                                                                        (Source: ValueResearch)

2. Concentration/over-allocation to risky sectors:

Like all other Mutual funds, Diversification is the main value that a debt fund promises to offer.

However, in the race to win clients and AUMs some fund houses over allocates to certain sectors in order to chase high yield.

One such example prevalent today is over-allocation to NBFC sectors.

If industry reports (UBS, Crisil, ICRA) are to be trusted, NBFC as a sector is expected to underperform due to economic headwind post-COVID 19 Lockdown.

So what shall be the fate of these Debt fund schemes holding a significant proportion of their AUMs in NBFC paper is everybody guesses. 

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3. Decreasing AUM leading to a flight of Quality papers              

AUM size should also be watched as in case of redemption by investors in difficult times such as now the only way to meet redemption by the funds is selling good quality bonds from its scheme(other is to borrow as last resort).

So after certain rounds what a scheme investor is left with is a celebrated portfolio of illiquid bonds with questionable credit quality.

Here is a list of debt schemes with around 30% redemption within the last quarter.

The return profile of such debt fund schemes (except BNP Paribas Low Duration) is disappointing

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Conclusion

The fate of an investor is always linked to his attentiveness as said by T Harvy Eker.

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Therefore, retail investors should keep eyes and ears open for these telltale signs before investing. And if somebody happens to own these schemes should consider exit as it is never too late to exit.

You can watch the following video to learn more about How to Select a Good Debt Fund:

 

How to select Good Debt Fund

Franklin Templeton Crisis Explained

Liquid Mutual Fund Simplified

Disclaimer: Views expressed above are personal.

Read more on Mutual Funds here.

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Amitabh Vatsya
Amitabh Vatsya is an active Investment Vlogger (http://youtube.com/c/Sadhansimplified) | Loves to share his ideas at http://wealthsutra.wordpress.com | Follow him @amitabhvatsya
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