How to check the portfolio quality of debt funds

Investors must carefully sieve MFs’ websites to ensure safety of investments

In troubled times, it is important to look at the quality of the portfolio of your debt funds. The risk of default is little more now since business cycles have been impacted. If you are not from a finance background but availing the services of a financial advisor, you can discuss the credit quality of the portfolio of your debt funds with him/her. If you are doing it yourself, you can at least form a perspective. We will tell you how.

The place to look for the portfolio is the website of the particular mutual fund (MF) or the asset management company (AMC). Every AMC declares its portfolios at least once a month, if not at a higher frequency. The month-end fact sheet is available as a download on the website. In the fact sheet, go to the particular fund, technically called the Scheme, in which you are invested or looking to invest. The Scheme fact sheet usually discloses the entire portfolio, except for one or two AMCs that disclose the top holdings only. Against every instrument in a debt portfolio, the credit rating is mentioned. To start with, go with the conventional approach of looking at the credit quality: AAA is the best, AA is good, A a little lower, etc. You may do the calculations yourself, or the pie chart may be given in the fact sheet, of the rating distribution of the portfolio. Obviously, the higher the extent of AAA and lower the extent of instruments rated lower than AAA, the better is the quality of the Scheme.

Now, some finer points about the credit rating. AAA, AA etc. are long-term ratings i.e. ratings for securities of remaining maturity of more than one year. The credit rating for papers with remaining maturity of less than one year is A1+ or A1 etc. However, most instruments of less than one year are rated A1+ as it is relatively easier for the issuers to obtain highest rating for them rather than the long-term instruments. Against government securities, which are the safest, you will see “sovereign” as the credit rating. Though, technically G-Secs are not rated by a rating agency, these are the safest.

Top-rated component

To arrive at the top-rated component of the portfolio, add the percentage exposure to AAA, A1+ and G-Secs. Another part of the portfolio to be added to the top notch is the cash or cash-equivalent, which also does not have any credit risk. Hence, the total top-rated component of one fund is to be compared with top-rated part of another fund, to form a perspective on the credit quality.

Credit rating distribution is an objective gauge. As an example, if one fund has 80% of its portfolio in AAA/G-Secs/cash and another fund has 60%, then 80% and 60% are comparable. There is another gauge to look at the credit quality, that is the category of issuer.

Within the same rating classification, there are shades. We have said G-Secs and AAA and A1+ are to be clubbed to form the top-rated component of the portfolio. Within this, G-Secs are better quality than AAA. If two funds have 80% top-notch exposure, the one with relatively higher exposure to G-Secs is better

In the short term i.e. remaining maturity of less than one year, certificates of deposit (CDs) issued by banks rated A1+ are better quality than commercial papers (CPs) issued by NBFCs rated A1+. The point here is, even though apparently credit rating is the same, CDs are of better quality than CPs due to the inherent safety of a bank over an NBFC.

To summarise the rating quality aspect, look at the percentage exposure to the top-notch instruments in the fund, and the category of issuers e.g. government over AAA-rated companies and banks over the NBFCs.

The portfolio credit quality or credit rating distribution is a function of the fund category as well, apart from the decision of the fund manager. There are 16 debt fund categories, and in a few of them, the nature of instruments in the portfolio is defined by SEBI norms. In corporate bond funds, a minimum of 80% has to be invested in instruments rated AA+ or AAA. In credit risk funds, a minimum of 65% has to be invested in papers rated less than AA+ i.e. AA and below.

In the category of funds called banking and PSUs, a minimum 80% has to be invested in instruments issued by banks and PSUs but the credit rating of the instruments is up to the AMC. In short duration funds, it is entirely at the discretion of the AMC. When you are trying to gauge the portfolio quality, you can look from this perspective: in a banking and PSU fund, 80% exposure is anyways to banks and PSUs, on top of that, if it is a AAA-oriented portfolio, the quality is that much better.

Having looked at the portfolio credit quality, the action point is this: for existing portfolios, if there is a reasonably high component of top-rated instruments and it is giving you comfort, stay invested. If it looks doubtful, you may look to exit. Note, do not exit in a tearing hurry. Before exiting, consider the exit load of the fund, if any and the tax implications.

For fresh investments, invest only in those portfolios that give you comfort. Defaults have happened in the past, even in AAA-rated instruments of IL&FS and DHFL, but if you are buying into a better quality product, you are that much better off.

(The author is founder, wiseinvestor.in )

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