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Rating Downgrade and Debt Funds

he rating downgrade of TELCO's debentures may pose another credit quality issues for bond funds. And its time that you check the credit quality apart from the returns before you invest in a bond fund.

Two weeks ago, a leading financial institution faced a credit rating downgrade and this week the auto major TELCO. The rating downgrade of IDBI bonds and certificates of deposit (CD) to AA+ from AAA, was for poor asset quality and reduced spreads. The new rating indicates high safety for these instruments compared to highest safety. However, the highest rating for IDBI's term money bonds and fixed deposits was reaffirmed. This week, Tata Engineering and Locomotive Company's (TELCO) non-convertible debenture issue faced a downgrade to AA- from AA, though the new rating still implies high safety. This comes on the back of sustained weakness in the company's operating profitability and lower demand for commercial vehicles.

The rating downgrade has implications for most bond funds, as these prominent outstanding debt issues will face some value erosion. As we reel in a slower economic growth, this might be a pointer to the emerging scenario. While investing in a bond fund, the greater focus has been the return performance of the fund in recent time periods, than an evaluation of its portfolio's credit quality. Today, it may not be enough to buy a bond fund just for its great performance in recent times and even sustained performance, as a fund can be a stellar performer by owning poor quality debt, which can turn sour one day. A close look at its diversification and portfolio has assumed greater significance now.

Rating downgrade apart, it's about time to lower your return expectation from your bond funds, as the consensus is building about the interest rates which have hit the floor. And the successive rate cuts which boosted fund performance in 2001 till date is unlikely to repeat.

Unit Scheme '64:
UTI opened the limited repurchase of 3000 units of Unit Scheme '64 on 1st August 2001. Though, the investors have been very anxious but the actual redemption was fairly low. In the first three days, 15824 unit holders redeemed 2.22 crore units, implying a redemption value of Rs 22.2 crore. Based on this revelation by UTI, the average request works out to around 1405 units per investor. Though it may be early to conclude on the magnitude of likely redemption, but based on the initial response, small investor of Unit Scheme '64 seems to be biting the guaranteed return carrot for the first 3000 units. The redemption price of US-64 will rise from Rs. 10 a unit by 10 paisa every month till May 2003, for the first 3000 unit holding account. Hence the price will be Rs. 10.50 in January 2002, Rs.11 in July 2002 and Rs. 12 in May 2003. Seemingly, it is just the end of a battle for UTI. The real litmus test of investors faith in the Trust will be in January 2002, when Unit Scheme '64 will open for unlimited redemption and sales linked to NAV.

Fund Update:
For the week ending August 03, 2001, the market gained 74 points (2.27%) on the Sensex and 54 points (3.52%) on BSE National Index. Technology and tech heavy equity funds posted the biggest gains for the week through Friday, rising an average of 5.1%. ING Growth Portfolio, the aggressive equity fund rose 9.92%, followed by other technology funds. FMCG funds were the laggards of the week, with the only loser being Magnum FMCG.