The spectre of credit risk may be looming large but the barrage of bad press on missing a monthly dividend is probably playing more on the minds of MIP fund managers. Thus, the quest to maintain a regular dividend stream has driven monthly income plans or MIPs towards lower rated bonds (for their higher coupon income) in the past six months. On the other hand, both equities and gilts have been largely left untouched due to their inherent volatility with bond yields also taking a knock.
Alliance MIP currently has a 46 per cent exposure to below triple A rated bonds (15% in March 2000) while the growth option for Templeton has a 43 per cent allocation. For Prudential-ICICI MIP, the investment has gone up from around 4 per cent to over 18 per cent in the same period. It is no different for Birla MIP, where AA paper accounts for 16 per cent of the portfolio in October against nil at the beginning of 2001.
Not Necessarily a Bad Investment
AA bonds in a fund's portfolio surely do not mean that these investments are bound to go belly up and cause a loss to investors. On the contrary, some lower rated bonds stand a chance of credit upgradation and thus, bring higher returns by way of capital appreciation. For instance, the AA (+/-) basket includes bonds from Ashok Leyland, Gujarat Ambuja Cement and Reliance Petroleum and some of them are more liquid than even AAA bonds.
Yet, fund managers should still avoid taking a large bet in lower rated bonds, especially in a deteriorating economy since this supposedly conservative strategy could backfire. If MIPs indeed plan to tread cautiously, there is no dearth of AAA paper - the Rs 1000-crore plus bond funds have staggering Rs 7,000 crore in top rated corporate bonds! On the other hand, the cumulative asset base for MIPs is only Rs 1036 crore.
While a lower rated bond may not go under, it definitely increases credit risk for the fund and default risk from the company. For instance, Consider a fund with a corpus of Rs 100 crore. Such a fund accrues interest of Rs 2.75 lakh per day (at about 10% p.a.). If there is a default of Rs 2 crore, the fund will not earn anything for a week! Two, only a small part of the AA securities is liquid and hence, a higher allocation here also impacts the overall liquidity. Further, the ability to sell quickly dries up with successive downgrades. "There could be more downgrades in AA+ and AA buckets in near future if the economic scenario remains awful," says Dhawal Dalal at DSP Merrill Lynch Mutual Fund.
Shunning Gilts and Equities
In the name of conservative management and their pursuit to produce a monthly cheque, fund managers have virtually shunned equities despite their mandate to lock up to 15 per cent of assets in the stock market. Thus, MIPs are being run like virtual bond funds. On the other hand, average investment in gilts has been only around 13 per cent though the current year has been a bonanza for gilt investors. However, neglecting other asset classes for their volatility is not the solution since MIPs are now overweight on credit risk. While capital loss on gilts or equities can still be recouped, credit default often causes an irreparable damage to the NAV. Clearly, fund managers should spread investments across varied risks and deliver optimum returns to investors. Anyway, the species of open-end MIPs does not assure returns and hence, it not obligatory to dole out regular dividends by assuming undue risks. If the portfolio allocation is not rectified soon, MIPs may go the US-64 way by misjudging/ignoring the underlying current in the market.