Loan Funds and Doubts – The New Indian Express

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Express press service

Debt mutual funds have been down and out of the picture with lackluster returns for not one, but two years now and, even worse, no visibility of a recovery on the cards. Not only have most categories of debt funds not performed well in calendar year 2021, they have also failed to match even the returns of term bank deposits.

Therefore, even after accounting for tax arbitrage for investors in the upper tax bracket, many investors seem to have reverted to their old path of investing by borrowing bank and corporate term deposits. If not a higher rate, these products at least offer much better visibility to these investors.

Investors in the fixed income category but less risk averse than traditional debt investors have begun to explore and some have migrated to hybrid funds, particularly of the low risk variety which features a hedging mechanism integrated.

Some who have no aversion to their funds being tied up for a period of time have even found solace in innovative insurance products that offer similar or even better returns, while at the same time offering the dual benefit of a insurance coverage and tax-exempt returns.

One exception is the debt mutual fund category where, as mentioned earlier, returns have been dismal lately, was the credit risk category. Some of the credit risk funds have generated returns of 9% in the twelve month period to around the end of January 2022).

Interestingly, this has not deterred investors from withdrawing their money from these funds. Long story short, the category’s Assets Under Management (AUM), which stood at Rs 55,000 crore plus about two years ago, almost halved to around Rs 28,000 crore at the end of calendar year 2021.

Now, there have been reports of investors who are open to taking on additional risk and have been told to consider a credit risk fund instead of an equity fund. This is confusing because the risk profile of investors in these two categories cannot be compared.

Of course, in the debt mutual fund investment space, an investor who is not only aware of the extra risk they are taking to secure the potential extra return can allocate a modest portion of their portfolio to the funds at credit risk.

The tightening of standards in the mutual fund category after the Franklin Templeton fiasco likely reduced the risk factor, but it could also simultaneously impact future returns, as risk and reward invariably go hand in hand.

Moreover, the fiasco mentioned above has led to a visibly more conservative approach by fund managers in this category because the fear of fallout from defaults is now much stronger than it was before.

It is therefore clear that the debt mutual fund sub-segment has a lot of work to do before it regains its status as the preferred investment among fixed income investors, and the complex structure of the tax on gains in capital in the segment is another hurdle in its path that needs to be overcome.

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