Rather than intellectualize and philosophize on impact, let us take a simple, practical approach. The performance of this category of funds, three years so far, will show us the net impact.
The traditional approach is to take the category average. The net of all defaults in the fund’s portfolio in this peer set, the average annual return over the three years as on 9 September 2021 is 1.82% in regular options and 2.64% in direct options. Not very encouraging, one would say, because investors got sub-optimal Return. However, to be kept in mind, this includes the worst phase of lapse in history.
Now let’s take another approach. The larger funds in this category have outperformed and the ones that have been affected the most are relatively smaller ones. That is, from a macro perspective, the impact on investors is not as bad as it seems from a simple average. Taking the corpus size as weightage, the weighted average over the three years as on 9 September 2021 is 7.66% in Regular Option and 8.38% in Direct Option. There is a notable difference between simple and weighted averages. If the larger funds that outperformed faced more defaults and the smaller funds outperformed, the overall impact on investors would have been much worse.
To take a few specific cases, HDFC Credit Risk Debt Fund with a corpus size of over Rs 8,000 crore has given returns of 9.28% and 9.81%. ICICI Prudential Credit Risk Fund with a corpus size of around Rs 8,000 crore has given returns of 8.82% and 9.56%. These two funds are the major contributors in pulling the average from 1.82% / 2.64% to 7.66% / 8.38%. On the other hand, the worst affected, BOI AXA Credit Risk Fund with returns of -31.98% and -31.8% has corpus size below Rs 100 crore. To that extent, the impact on investors has been limited.
If you have to take a look at credit risk funds, you should see:
- Portfolio YTM: Higher YTM has an inherent attractiveness. However, if the YTM is significantly higher than that of the peer group, it means a relatively high level of credit risk.
- Credit Rating Distribution of Portfolio: Structure in terms of AAA, AA, A, etc. Obviously, the higher the rating, the better.
- Portfolio Concentration: The more concentrated the portfolio, the worse it is. After IL&FS and DHFL, we know that AAA unit can also default. Though SEBI’s limit is 10% per issuer, within the limit, if an AMC maintains a more diversified portfolio, it is better. An equity fund portfolio with 100 papers is over-diversified, but there is no over-diversification in a debt portfolio.
- Skin at play: If the AMC itself is investing in its own credit risk funds, it shows the level of confidence.
- Subsequent process, and track record of AMC.
(The author is a corporate trainer and author.)