Debt Funds: No Safety Tag

FROM THE NBFC LIQUIDITY CRISIS IN 2018 TO COLLAPSE OF SIX FRANKLIN TEMPLETON SCHEMES, DEBT FUNDS ARE NO LONGER CONSIDERED SAFE

- NAVEEN KUMAR

In April 23, US-based Franklin Templeton announced a decision to wind up six debt mutual fund schemes in India owing to the liquidity crisis in the wake of the coronavirus outbreak. The news rattled investor confidence and, on April 28, five days later, credit risk funds witnessed one of the biggest single-day redemptions – the process of selling units – with assets under management (AUM) falling by ₹5,223 crore.

The episode busted the myth surrounding safety of debt funds. A debt fund invests in fixed income instruments such as bonds, corporate debt securities and money market instruments. In fact, credit risk funds (debt funds that mainly invest in low-rated securities giving high returns) saw a 36.53 per cent fall in AUM during April 23-May 20, the latest data released by the Association of Mutual Funds in India (AMFI) shows.

The Reserve Bank of India’s (RBI’s) ₹50,000 crore liquidity window for debt funds to manage redemptions prevented contagion but another shock is likely to aggravate the situation.

We look at some of the most affected debt fund schemes and categories to help you review your investments and take necessary steps.

Investors Worst-affected

Initially, Franklin Templeton tried to manage redemption requests by selling good quality paper, but the situation went out of control. “As AUM shrunk, the fund was left with a higher proportion of less liquid and probably riskier investments. It borrowed money to pay for redemptions but hit the regulatory limit for borrowing,” says Prateek Mehta, Co-founder of Scripbox, a mutual fund investment platform. After this, the fund had no choice, but to side-pocket the entire fund.