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Future of debt mutual funds

Dhirendra Kumar discusses the crisis in debt mutual funds and what the future holds for these funds

Given the recent defaults and downgrades in debt funds, how do you see the future unfolding for them?

There are two aspects of the debt fund crisis. First, the economic outlook looks negative. Companies are neither able to produce products nor make products available to their customers. On the other hand, customers are not stepping out to buy things which means earnings of companies are gone. In such a situation, while some companies may be able to honour their commitments, some of them will falter.

Second, we invest our money in debt funds which in turn invest in the bonds of several companies. When investors want to withdraw money, fund managers generally sell those bonds in the market, realise the money and return it to you. In the current scenario, that market is frozen, so fund managers are finding it extremely difficult to repay. And ever since the Franklin episode, investors have been queuing up to redeem their money.
You would have seen the statistics of investors pulling their money out. Although the pace has decelerated, it is still continuing. The scale of money being withdrawn from debt funds itself is causing the crisis.

So, I have always held this view that the risk for debt-fund investors doesn't come from the underlying companies not paying the principal and interest on time but it is generally because a lot of investors act at the same time. This causes a big problem because the debt market is not so liquid.

As we do not know the length of the crisis, all bets are off on debt. And it is important to humbly accept this fact because if you build expectations around optimism, then disappointment from debt funds will be very severe. So, I would say that err on the side of caution. Make sure that the money that you need in the immediate term should be invested conservatively and cautiously. Do not get greedy with this money.

At the same time, the way debt is priced today, it could be extremely rewarding for somebody who is planning to venture there. So, if you have long-term money invested in reasonable quality debt funds, then do not panic. Because despite all this, Indian debt funds have been managed well. Today we are referring to AA-rated papers as default grade, which is not true. This is the extreme point of pessimism or one can say it's the circumstance that is making it look like that.