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IDBI Downgrade Poses Fresh Challenge

Apart from the short-term impact on NAVs, the downgrade brings to the fore the larger issue of credit risk faced by your bond fund.

If you thought you are relatively insulated from the vagaries of the IDBI downgrade, hold on. The downgrade of Industrial Development Bank of India (IDBI) by rating agency, Crisil could pose fresh problems for your bond funds, which are still reeling under the impact of a sharp fall in bond prices last week. This also once again highlights the issue of credit quality, which has been one of the key ingredients in the sales pitch for bond funds. The June portfolios reveal that most bond and cash funds hold sizeable investments in term-lending institution's debt securities across various time periods. The cumulative investment of funds in IDBI bonds on June 30 is estimated at Rs 1316.5 crore.

Top Fund Exposure to IDBI
Fund  % Exposure*
Dundee Bond PSU 18.3
Zurich India Liquidity Saving 14.59
Reliance Liquid Treasury Plan 14.54
Birla Cash Plus 12.94
Zurich India Liquidity Inv 12.72
Alliance Cash Manager 12.47
Franklin India Balanced 12.32
PNB Debt 11.89
Sundaram Money 11.62
Templeton MIP 11.42
"*On June 30, 2001"

The downgrade could especially jolt short-term debt or cash funds if it drains out liquidity from IDBI papers. These funds attract investments for a very short-duration and hence, own a portfolio of very liquid bonds. The impact of the downgrade has already hit trading in the financial institution's paper with a drop in prices in the range of Re 1, leading to a jump in yields. Thus, this is bound to pull down the net asset values.

"The bids have vanished and offers have gone up by 30 basis points,'' says Dhawal Dalal at DSP Merrill Lynch Mutual Fund. DSPML's bond fund had a 4.38 per cent exposure in IDBI papers on June 30, 2001. However, the buck does not stop here. The downgrade could spillover and pull up yields on bonds of other financial institutions like ICICI, which are also faced with concerns on asset quality. "The reasons behind IDBI's downgrade hold true for ICICI as well,'' adds Dalal. The quality of assets is especially paramount amidst the current economic slowdown, where downgrades could be the order of the day as income stream is stifled.

The ratings of IDBI bonds and certificates of deposit (CD) was downgraded one notch by Crisil to AA+ from AAA, citing poor asset quality and reduced spreads. The new rating indicates high safety for these instruments compared to highest safety. The lower rating will push up spreads on yields of IDBI paper over other corporate and government bonds, which could now settle around 110-120 basis points. However, the rating agency reaffirmed its highest rating for IDBI's term money bonds and fixed deposits.

While there is hardly any buying interest in IDBI paper, credit-conscious fund managers are itching to offload the same to maintain their investments in only top rated bonds. For, in one go, a part of their portfolio has seen a dilution in quality. For instance, Dundee Bond PSU had 18% holding in IDBI bonds on June 30. "Yes, we had that exposure but currently, the fund holds no exposure,'' says Akhilesh Gupta at Dundee Mutual Fund. However, the AMC's liquid fund still has an investment of Rs 5 crore in IDBI paper.

Lessons from Downgrade
Apart from the short-term impact on NAVs, the downgrade brings to the fore the larger issue of credit risk faced by your bond fund. While it is difficult for an investor to anticipate a downgrade, it is important to keep a close tab on the asset quality of fund's investments and not be guided by returns alone. For, sparkling returns could very easily be generated on the back of a poor quality portfolio, which may turn sour one fine day. For, all that glitters is not gold!