The Mutual Fund Show: Should Investors Consider Credit Risk Funds?

Shalini Dhawan: One of the things that always comes to mind when we look at hindsight and say which fund did well, all of us can pinpoint and say look at the risk at this point in time. 

If you look at some of the data, even liquid funds look very good, in that sense. So, the point about switching out from credit risk or into what category one should switch out, the point is you are switching for what sort of thought process: Is it to improve your returns or to reduce risk because credit risk funds—as we do understand—do have a higher level of risk if you compare it to the liquid or across the spectrum of debt funds as well… 

Two, what is the goal? Are we returning to optimise risk, are we trying to book in the returns, is it long-term and so on… and then kind of take a call saying that has it actually delivered to what we are trying to do or why we went into it in the first place knowing the risk of that scheme. So, the switching is dependent on that. 

If you think you are an investor who has the risk profile, then you could really continue with some part of your money in credit risk. But again, what was the thought by which you came into that scheme is important. 

…When you switch out from somewhere, you are trying to see what looks good. Again, here, it depends on what you are trying to add to your portfolio, because you are talking about non-equity. So, are you trying to add temporary parking because you want to take a stand that I will just put money in debt and then move to equity at some point in time. Then obviously, there are many different categories to look at, or are you trying to look at saying that on a post-expense situation, my credit risk has not really given me the kind of yields or returns that I am expecting. So, then there are other categories to look at—maybe medium-term or in the short-term. 

Arun Chulani: Essentially, I haven't really recommended anyone to invest. I guess this is a hypothetical question. 

I wouldn't be too excited about this space because, as Shalini mentioned, hindsight is a wonderful thing and if someone's to take risks, my real thought process would be to look at equity. 

Essentially, you are taking credit risk to go into lower quality papers and yet your returns will be capped at whatever they are. Also, you have to look at the global situation in terms of the macros and the headwinds. It is likely —it's not a definite—that earning qualities will reduce. 

Also, we have got QT (quantitative tightening) in terms of the Fed increasing and obviously, other central banks following in turn. So again, these low-quality papers may or may not struggle to make these payments. 

Rather than take this bet, and again, I will have to face volatility possibly, I have to look at three to five years as a kind of holding period and I would be taking all that risk, but probably not too much more than other standard and lower risk debt products. So, if I really wanted to look at my portfolio, I would rather go into equity ownership because here's a real chance to be part of India's wealth creation. 

Again, we have to look at maybe five or 10 years with the viewpoint that there may be near-term volatility, but here you are buying ownership and perhaps even quality companies and your returns are not capped in many respects.

Shalini Dhawan: For someone who is looking at moderating their risk or has a moderate risk profile, and I am guessing that we are still talking about the debt space, in which case, what happens then is that we are talking about taking a measured level of risk. 

Here's where the expense ratios of some of the funds do come into play because if you talk about a credit risk fund, not going by the past one-year return, but if I am looking at potential yield going forward and if I would just take any sample good-rated credit risk fund like an HDFC Credit Risk or Kotak Credit Risk Fund, the yield-to-maturity today are in the range of around 8.5-8.2%. 

Now, if I were to understand the post-expense because the yield is an indicator of potential return, and the expense will obviously eat out the yield to some extent. The regular plan expense ratios are pretty high. They are in the range of 1.3%-1.5%. 

That kind of eats up into the credit risk yield and therefore, the thought is that if I was at 8.5% and 1.5% is going away in an expense ratio, and I am left with 7% expected yield, then why should I take that kind of risk? That's not what I would suggest. 

I would probably ask them to go to a medium-term fund or a short-term fund, which probably has a yield-to-maturity of 7.5% or 8%. But then correspondingly, it also has a lower expense ratio… 

Let’s say, if we are talking about a medium-term fund, and here's where some of the other work around regular plans and direct plans would come into the picture for an investor, which we can delve upon later. But we are also talking about a medium-term fund, which has a yield of around 8% or so, and if you are talking about expense ratio—the direct plan expense ratio—and if it's somewhere in the range of 0.7% or so, then you are talking about a very good yield. So, you are taking the yield into your portfolio without necessarily taking a credit risk. 

So, you are taking a medium-term kind of bond fund, but you are not taking the credit risk, which could be something that could be like volatility, could be so many other things introduced into a moderate risk profile person’s portfolio. 

You could shift to a medium-term fund or even a little lower than that risk could be a short-term fund, where the same logic holds that the yield to maturities is somewhere in the range around 7.5% or so. But then on a direct plan also, if you see, you have your expense ratios which are as low as 0.2% or 0.3%. So, that actually is improving your yield without taking any kind of credit risk.

Shalini Dhawan: Well, many of the leading names do have good short-term funds, of course. So, the kind of choice there is a little bit more. Some of the better, I mean the older known names, like HDFC have good medium-term funds. 

Obviously, there would be some reading needed by the investor to understand what they are going into if they are not going into the credit risk because of the risk, or if they are in credit risk but they want to move out. 

Arun Chulani: From my understanding, it's simply the ownership that has really changed. The real operational management seems to be still in place, with the same strategies and same aspects.

Of course, given the Bandhan consortium doesn't have an existing platform in this space, there's no merger of schemes. 

If you have seen in previous acquisitions, there have been various mergers because according to SEBI, you can only have one scheme in a certain category. So, as this is a new platform product, it's business as normal, at least as far as I am aware.

Shalini Dhawan: No, it is similar to Arun’s. The stake sale has gone to a combination of new holders, which is Bandhan GIC and ChrysCapital. So yes, it is a stake sale. 

From what I understand, the investment philosophy of IDFC has usually been in the debt fund, the underlying have been a lot of G-Secs, government securities, AAA-rated bonds. So, they have always led the bond schemes to be of quite high quality. That also is a comfort factor for people who are already in the IDFC schemes. I would say it's business as usual. But all investors need to track their portfolios and schemes, just to make sure that things are remaining on track.

Shalini Dhawan: It is seamless, in that sense. Yes, there are items to keep in mind.

The first is that moving out of a regular fund, even if you are wanting to move to a direct fund, is considered a sale or an exit. So, the moment we are talking about an exit, there is an exit load that you have to keep track of, so you cannot forget that. 

The second thing is that because you haven't made an exit, depending on whether it is equity or debt, short-term or long-term, you have to think about what tax impact will happen on the movement from regular to direct. So, that's another item. 

Some AMCs are investor-friendly. They had announced in the past that they would not charge an exit load if investors wanted to go from regular to direct. There are a few I think. 

The more important item here is that can the investor keep track of all this—invest in direct, also keep track of his/her emotions, and the portfolio altogether. So, if not, then the combination of an advisor and a direct plan would be better. 

But yes, keep these things in mind. These are important: exit loans, taxation…

Arun Chulani: For sure, you pay a little extra for the regular plans, but here you are able to do your day job. Everyone has their own job to do as the advisor has his job, and he will be able hopefully—if you have done proper references, find the right one—provide you with the information, give you a better plan allocation for your own risk and return metrics and also do the reporting for you. 

Whereas if you are a bit more sophisticated and have time on your hands, perhaps that's where you'd like to go to your direct method and have a bit more control on your aspects. But let's say, most of us who are working and very busy in our day jobs, it might be a better idea to have that someone give you good advice. 

Maybe for the HNIs, there are platforms available for either a return on sensitive AUM or retainer fee, where you will get more access to slightly more sophisticated products as well as perhaps more one-on-one time… 

It's a real trade-off, whether you are able to do the work yourself or you are happy to pay someone else to do it.

Arun Chulani: Well, my suggestion would be (depending on) your risk, how much volatility are you able to take. 

I always look at intrinsic versus extrinsic value. So, I am not really concerned for the most part with the volatility as long as there's no structural change to the intrinsic value. 

Because of our viewpoint or my viewpoint of India itself, and my belief that there are a lot of tailwinds ensuring hopefully this will be our golden decade—digitisation, China plus one, to minus China itself reducing capacity. 

At least, if you have a long-term viewpoint and you are able to have the right philosophy, SIP your investments in by staggering into the market and park away this money. So, essentially you don't need it for the short term or even the medium term or long term. Let it do its work. 

Obviously, there's a categorisation and if you are less volatile or less (of a) risk-taker, then perhaps go for big caps. But if you want your money to really work compound, perhaps look at the mid caps, which are slightly opaque to many people, need a bit of work, need a bit of polishing and maybe the information isn't there. But because of this, there may be some...alpha creation within the space. So, (if) I really want to make my money work, this is where I would be looking at perhaps in the long term.

Shalini Dhawan: We have been singing this song for a while that a lot of the index orientation is pretty expensive, and we aren't seeing the kind of earning estimates justify the levels of the Nifty and the Sensex. But there is also this opposite view—we are aware of this long-term decadal growth. 

If I had to put my money, I would possibly look at value funds or some flexi cap funds. Not necessarily go for the large or the giant players. I would possibly look at a flexi cap scheme. I would definitely look at some international allocation. International valuations are looking more attractive than India. I would definitely look at international markets. It's a risky stand, of course. 

If you are an equity investor, you should be ready for the 5-7-10-year horizon. So, I will look at a mix of that.