You can`t do anything, except waiting, to get your money back if you have investments in the 6 debt funds schemes which has been closed by Franklin Templeton. The only way is to wait and watch how the fund house is going to realize the securities and pay to you. You may get your entire money back or may get 70%/80%/90% of your money. It depends on how many companies will default on their commitments due to the present crisis.
Since you cannot do anything for these 6 funds, it is time to do a reality check for other debt investments in your portfolio.
All debt funds are not for you
There is a general belief among some investors that all debt funds are like fixed deposits and are safe. The fact is that no debt fund is equal to FD. Depending on the type of securities where debt fund invest, it carries different risks. The important risks in debt funds are (1) interest rate risk and (2) credit risk.
In a situation like this where RBI is reducing interest rate, long term debt funds can give higher returns. There are some debt funds which have given 12% or more return in the last 1 year! But when RBI change the stand and start increasing the interest rates, your gains will be lost. To make money in long term debt fund is not that easy. For a retail investor, it is better to avoid such funds.
Credit risk is there in all types of debt funds. This risk is managed by the fund managers. They do it based on their own research and also through the ratings by various rating agencies. The fund manager will invest in securities of high quality to ensure that the investor’s money is safe.
To make things complex and to cater to the needs of different types of investors, there are many debt funds in the market. Overnight Funds, Liquid Funds, Ultra Shot term Debt funds, Short Term debt funds, Medium Term Funds, Long Term funds, dynamic bond funds, Credit risk funds, Corporate bond funds, Gilt Funds, Fixed Maturity Plans are etc are common types.
If you are a retail investor and if you don’t want to take higher risk for a likely higher return, stick to the first 3 types of debt funds only – Overnight Funds, Liquid Funds and Ultra Short Term Debt Funds.
If you are having debt mutual funds in your portfolio, check the percentage of investments in funds other than overnight funds, liquid and ultra short term debt funds.
Withdraw from Credit Risk Funds if you don’t know the risk in these funds
This fund is not suitable for all investors. This is suitable only for matured investors who are ready to take extra risk for a likely extra return. Such matured investors will generally invest only a small portion of their debt portfolio in these funds. Credit-risk funds invest heavily in low rated securities which can give you higher return with higher volatility. In normal situation, the fund manager can create a higher return in these funds by suitably managing the risk. But the present COVID situation and lock down can force many companies to default or delay on their payments and the ratings can go down further. This can result in fall in NAV of these funds. If there is a redemption pressure, it will not be easy for the fund house to realize these securities and pay to investors because low rated securities are not so liquid. It will become difficult even for an experienced fund manager to handle this liquidity situation.
If you have invested in such funds without understanding these facts, it is better to exit from these funds. Otherwise, you can hold on to such funds.
Check composition of Debt Mutual Funds
Please check the portfolio of your debt mutual funds. You can check it in many portals like Morningstar or Valueresearchonline. I am talking about all mutual funds be it liquid fund or credit risk funds. Let us check the portfolio composition of Franklin Ultra Short Term Bond fund which is also in the list of 6 funds which has been closed now.
Most of the assets are in debentures that too in low rated private companies. The portfolio composition is also more than 5% in the first 2 cases. Again some companies have exposure of more than 6.50% through different instruments – if you look carefully.
Now let us compare it with Aditya Birla Sunlife Savings Fund
Can you see the difference between companies both funds have invested? Can you see the difference between the ratings of those companies? I am not saying that these companies cannot default – but the chances are less. (Please don’t consider this as a recommendation to invest. This is for explanation purpose only)
So, any investments in debt mutual funds which have high concentration into a company (other than the GOI companies or bonds), or investment in low rated companies, please come out of it, unless you are investing in those funds understanding the risk.
Diversification in Debt Mutual Funds
Now that you have checked your portfolio composition, it is time to diversify. Even if you are 100% sure that the composition of portfolio is right and the mutual fund company is good, diversify it. Diversification here means different mutual fund companies and not the different funds in same company. Choose atleast 2/3 companies to invest in debt mutual funds.
Moving from Debt Funds to FDs/ Investing in FD
If you have any goal which is less than 3 years away, move the amount from debt funds to FDs. We still do not know how this corona virus will impact the industries? Debt funds are suggested for tax efficiency and not for returns. Though you will have to pay an additional amount of tax if you move to FDs from debt mutual funds, it is better to play safe than sorry.
Remember, I am talking to withdraw the amount for the goals which are less than 3 years away. Do not start withdrawing your entire investments from debt mutual funds. No need to stop your SIPs in liquid fund and Ultra short term debt fund – these are suggested as debt component for long term goals. Please continue them.
Ripple Effect to other debt mutual funds – Should I withdraw?
Are there any chances that there would a ripple effect on other debt mutual funds? Yes, there can be ripple effect on other funds too if people start withdrawing from other debt funds in large scale. If large number of people starts withdrawing from other mutual funds, there would be liquidity issues as the maturity period of investments is defined in most of the debt instruments.
If there is high liquidity pressure, the companies will start selling their bonds/debentures in the market. With the current situation, there would be very few buyers who will be interested in buying these investments. Those who will buy will take it at much lower rates than the actual worth of these investments which in turn will reduce your NAV and it will impact your returns.
RBI is trying to increase the liquidity in the system to manage such situation. It is welcome step.
But, do not withdraw if you are sure that you have invested in good debt mutual funds as explained earlier. There is no need to panic.
Ripple Effect to other equity mutual funds- Should I withdraw?
Yes, this can impact your equity mutual funds too. Think about it, people were very sure about debt mutual funds. Now with one company, closing its 6 debt mutual funds, there would be definitely a loss of trust. People will not lose trust only in one company, it will definitely impact other companies also.
And when people lose trust in debt instruments, the chances of trusting equity mutual funds would be far-fetched dream. I am not talking about the investors who know their goals, who know that equity investments are for long term and you have to be patient. But how many investors are there who actually invest as per their goals. Good number of the investors are just investing to earn that 1%/2% extra returns. Lot of people invests in equity mutual funds because their colleague/friends say so.
If you are not investing as per your goals or were investing as per the advice of your colleague/friends, you should never have invested in equity. If you are investing for long term goals as per your asset allocation, do not withdraw. The markets will recover ultimately and you will be the winner if you continue to invest in these volatile markets. Don’t stop your investments unless you face a job loss type situation.
Debt funds for NRI Investors
There is no need for NRI investors to invest in Debt Funds. For them, Fixed Deposit and Recurring deposit from NRE account is better than debt funds, because interest from those is tax free in India.
Why all this now? The article should have come much before this crisis
Ok, these are the things which I always tell my clients in the last 10 years. I have never suggested anything like credit risk funds. In fact, I never suggested anything other than liquid funds and ultra short term debt funds within debt funds. My first preference has always been PPF/VPF for retirement goal and Sukanya Samriddhi Account for daughter`s marriage goal (of course for the debt part). I thought of writing this article as everyone is worried about their debt investments.
Feel free to write me at email@example.com if you have any queries.