Letters to the Editor's Note

Summary: Debt funds rarely warn before they hurt. That quiet risk is what many investors learn only after the damage is done. Readers respond to why debt fund ratings needed a rethink, and what really matters when returns look calm but risks aren’t.

Dhirendra Kumar’s Editor’s Note, A new lens for debt funds, published on January 3, 2026, explained why past returns alone can be dangerously misleading when evaluating debt funds, especially in seemingly calm market phases. He unpacked how hidden credit and concentration risks often surface only when it’s too late and why ratings must account for these risks upfront.

The piece resonated with readers who have learnt, sometimes painfully, that debt fund risks are quieter, rarer and far more sudden than equity volatility.

Summary

For over three decades, Value Research’s fund ratings have helped investors cut through noise. That purpose remains unchanged. What has changed is the nature of risk in debt funds, and the ratings must reflect that reality.

Debt fund risk does not announce itself as equity risk does. Equity volatility is visible and frequent. Debt funds feel reassuringly stable. Returns accrue steadily, NAVs rise quietly, and suddenly, a single credit event can erase years of gains. Credit risk stays hidden during good times, which is precisely why judging debt funds by returns alone has always been inadequate, even dangerous.

This problem becomes clear when two funds deliver similar returns over several years. One may have achieved them through disciplined exposure to high-quality paper; the other by stretching into lower-rated bonds. In benign periods, the riskier fund can even look superior. The difference only becomes apparent when trouble strikes, by which time it’s too late.

The question that matters is not just how much a fund returned, but whether those returns were commensurate with the risk it took on. Concentration risk further complicates matters. A portfolio may appear diversified, yet be heavily exposed to a single corporate group. Episodes like IL&FS and DHFL showed how such hidden risks can devastate investors.

From this month, credit quality and concentration become explicit inputs in Value Research’s debt fund ratings. Funds that accumulate hidden risk face rating caps, regardless of strong past returns. Some funds may lose top ratings; others with modest returns may stand out for their prudence. In some categories, the absence of high ratings itself becomes a warning.

The upgrade reinforces a simple message: debt funds can play a valuable role but only when risk, not just returns, is clearly understood.

For readers who want to go deeper, the upgraded rating methodology explains how this is built into the process.

What our readers say

• As one of the sufferers in DHFL and SREI, where I lost substantial amounts, I would like to add a few points. I have serious doubts about the credibility of credit ratings awarded by reputed agencies. How does a “AAA”-rated entity suddenly collapse to “B-” overnight, as happened in these cases?

Also, investors in NCDs must be extremely cautious. Though these instruments are said to be tradable on exchanges, in reality, they often fetch distress-sale values once the issuing company deteriorates financially. - Dhruba Ray

• I fully agree with your philosophy of evaluating debt funds through a deeper analysis of their investing patterns. That said, I would have expected this kind of due diligence to be applied all along. Still, it’s better late than never. - Raghu Kopalle
• This article deals very well with credit risk and concentration risk. You’ve explained the upgrade to VRO’s debt fund ratings by incorporating these risks into the evaluation framework, which will greatly benefit investors.

That said, the article does not explicitly mention two other important risks in debt funds—interest rate (price) risk and liquidity risk. Liquidity risk, in particular, is crucial for short-term investors and contingency funds. Many will recall the liquidity stress faced by debt funds a few years ago. I’m sure the VRO rating methodology already captures these risks adequately. - Debendra Nath Panigrahi

• The article on debt funds is a real eye-opener for retail investors. The inclusion of credit quality and concentration of investments in individual issuers into Value Research’s debt fund rating framework will certainly present a more accurate and realistic assessment of debt funds across AMCs.

I have been a retail investor in equity, mutual funds and debt instruments for over 25 years and a regular reader of your articles. - CA Amitava Dutta

• Having experienced setbacks in three debt funds of an AMC, I vividly remember the shock of realising there was far more risk than I had understood. You’ve raised an excellent point, and the fact that this will reflect in your rating system is reassuring. Thank you very much. - Srinivas Shenoy
• I agree with your views, as they are based on logical reasoning and hard-earned experience. I had invested a fairly large amount in DHFL. Fortunately, I was able to prematurely close my fixed deposits. However, I did suffer losses in NCDs, where I could do nothing, despite them being rated “AAA” by all agencies at the time. - Ponnudurai Ratna
• Not only IL&FS and DHFL, but also the failure of Franklin Templeton Mutual Fund’s six debt-oriented schemes—including segregated portfolios for Yes Bank—is well known. Investors are yet to receive money from the segregated portfolios. Whenever I write to the fund house, I receive a standard response stating that the matter is sub judice before the Hon’ble Supreme Court.

In the remaining schemes, the Hon’ble Supreme Court appointed SBI Capital Markets, which sold the underlying securities and returned money to investors. Similarly, Axis Mutual Fund uncovered dishonesty by its fund manager, Viral Joshi.

While rating debt or equity funds, I would urge that the honesty and integrity of fund managers—who handle lakhs of crores of common investors’ money—also be factored in. - Sarita Pandya

Also read: We've upgraded our debt fund ratings. Here's what to know

This article was originally published on January 20, 2026.