What does SEBI's recent tweak in side-pocketing norms in view of the COVID situation mean to retail investors? Does investing in debt funds still make sense for retail investors, even when high-quality papers can be side pocketed without any actual downgrade or a credit event?
This tweaking is very useful. Here, the regulator has allowed mutual fund companies to segregate debt exposure to the securities of those companies that have approached them for debt restructuring because of the COVID-19 stress.
If you remember, we saw a significant side pocketing or segregation of portfolio in January by Franklin Templeton where a sizable part was segregated. Nevertheless, as the rules stated, a fund manager could not segregate a portfolio unless and until there is a credit action. Hence, it took six-seven days for the fund to acknowledge and follow the rule and do that segregation. Now the money went down in value on that very day itself because of the valuation and the portfolio was segregated after seven days. But all the investors who got out of the fund within those next seven days lost the money, as they were not part of the segregated portfolio. Hence, both segregation of portfolio and segregation of the portfolio in a timely fashion are equally important.
I feel the regulator has done this tweak in view of the practicality of the present situation. It is basically learning from their own experiences. Moreover, it was done with the expectation that we would face such credit issues more often as and when the companies start getting out of the moratorium.
I would say that to err on the side of caution, you have to really evaluate whether it is worth taking any risk. The other side of the problem is that the yields or returns have come down so low that if you are essentially depending on the interest, then you will have to take some risks. Now, you have to figure out how to take that risk in a measured way so that you are not hurt badly. For that, focus on quality, don't get distracted by noise, look at a fund's credit rating, exercise your diligence, be very selective and don't get influenced by the highest returning debt fund, as that is the first red flag that comes to my mind.