The Risk Factor

Attempts to increase yields are making fund managers shift towards riskier securities.

- Deepika Asthana

It is a truism of investment I that high returns go hand in hand with high risk. When the economy is doing well, most investors focus on returns alone, not paying sufficient heed to risk. Mutual funds, which have taken a hit due to defaults by two Essel Group companies, are no different. The Essel Group companies, to which mutual funds have lent a combined 7,000 crore against debt securities, are now unable to honour some of their immediate term obligations. There has been deferment of payout, rollover and haircuts in arguably the safest product in fixed income. Kotak Mahindra AMC has reportedly informed its investors that it may not be able to immediately redeem the entire amounts in multiple schemes, while HDFC AMC, India’s largest asset manager, has extended the maturity of one of its fixed maturity plans maturing on April 15 to April 29. Last year, too, after Infrastructure Leasing and Financial Services (IL&FS) defaulted on inter-corporate deposits and bond repayments, funds were caught on the wrong foot. The 33 bonds and hybrid funds that had cumulatively invested 2,900 crore in the company suffered losses when credit agencies lowered IL&FS ratings to junk.

Unfortunately, these are not isolated events. Managers of lakhs of crores of debt mutual fund money – in search of extra returns in a market that has been subdued for years due to a tight interest rate regime – have been chasing riskier/high-yielding debt securities, though staying within regulatory limits. To make things worse, after the IL&FS meltdown, non-banking finance companies (NBFCs) and housing finance companies (HFCs) have been further widening their credit spreads, leading to some degree of concern, given how heavily fixed income funds are invested in them.