Is Debt dead forever?

As you all know, Franklin Templeton wound down six of their schemes which had credit risk exposures. It was shocking for investors. They lost liquidity. Fear spread out. Enough is written on same in last few days.

Now, let's look at - how did market react to the same?

First & foremost - let's not panic, looking at high double digit and triple digit negative numbers, in this table 1. It's just mathematical multiplication, just to show Annualized Return. Still, it is scary. It was expected, considering the unprecedented event of winding down of debt schemes. Worry is the rippling effect on other Debt schemes performance.

Does it mean that investors are moving out from all Debt schemes? All Debt schemes have lost trust from investors and are they going back to Bank Deposits or other alternatives.

Let's look at Assets Under Management (AuM) movement of few debt categories and picture should be clear.

Looking at the table 2, as expected, investors have definitely panicked out of Credit Risk Funds & Medium Term Debt Funds. Here, we have taken sample of top 10 credit risk schemes based on AuM (as on 31mar20). With a very few exceptions, Credit Risk Schemes have lost AuM of more than 30% - in just one month. This is over & above, what they would have lost AuM during the month of February 2020 & March 2020 - because of global spread of pandemic, announcement of Lock-down in India and financial year-end phenomenon. Yes, this is pretty serious. Lack of liquidity is what hit the psychology of investors.

Here, in table 3, we have taken the AuM of top 10 schemes from the category of Corporate Bond Funds & Banking & PSU Debt Funds. Under current scenario, these are the categories of funds schemes which have highest quality of debt papers. All schemes have seen increase in AuM, during the month.

It just shows FLIGHT TO SAFETY.

When we look at numbers in all three tables together, the picture is clear. Investors are definitely fleeing from aggressive debt schemes to conservative debt schemes. And as a result of the same, prices would have dropped even for high quality debt papers (yield would have hardened). Reportedly, few of banking perpetual bonds got traded at very high yields - 12% to 14% compared to 8%-9% earlier. This means mark to market impact on performance of high quality debt funds as well - without major outflow from such high quality debt funds.

Positive way to look at this whole incident is that despite being such a serious outflow from Credit Risk funds, all such fund schemes could meet the redemption pressure. This redemption pressure, we assume, would have created a dent on few high quality debt papers, in terms of mark to market loss. This could be very well temporary. Unless, we get to hear one more run on some other Debt scheme.

Though, seems unlikely, looking at liquidity assistance being provided by RBI.

Lessons for stakeholders -

Few lessons for investors & advisors, here.

1. Review underlying holdings of debt schemes one is owning & monitor yourself or question your advisors, about the same.
2. Construct the portfolio with CORE & SATELLITE HOLDINGS strategy. CORE holdings should be occupied by high quality debt instruments. So that in normal environment, it does not give any surprise. SATELLITE holdings or ALPHA call could be based on one's view on DURATION or CREDIT. If one expects interest rates to go down, then as DURATION call, one can invest in longer tenured debt scheme. And if one has a view on economic recovery, then probably one can participate in CREDIT RISK funds. As it suggests, this is view based & has to be tactically done for a shorter time - perhaps for few months or quarters. And as view materialises, one has to go back to CORE holdings. This should help investors in placing RISK as a priority over RETURN.

Few lessons for Fund Managers and Regulators, as well.

1. Fund Managers need to construct the portfolio keeping in mind SAFETY & LIQUIDITY as a priority for investors. Accordingly, even AGGRESSIVE products like CREDIT RISK Funds as well, will have some 20-40% exposure to easily liquid-able high quality debt papers.
2. Fund Managers with the help of their internal RISK team need to have tight risk control mechanism. One of the parameter to monitor could be six months average daily trading volume vis-a-vis Holdings in a particular scheme. Regulators may require the AMC to submit the regular report on the same. Through this, AMCs would be forced to invest in trade-able investment products more than Banking or Lending products.
3. Dissemination of more data-points should be enforced. Let investors make knowledgeable decisions. These data-points need to cover aspects like Trading Volume vs. Holdings, Maturity profile, explanation on structuring or re-structuring of any complex transaction, etc.

Probably, there could be a few more lessons for all the stakeholders.

As its said 'Never let a good crisis go to waste'. We need to constantly learn and improve....