What Should Investment In Debt Funds For Short Term Look Like?
Aug 23, 2019

Author: Aditi Murkute

(Image source: freepik.com, photo credit: creativeart)

When you invest, your sole intent is to see the growth of your principal amount without any loss of capital. Hence, you choose funds that could have lower risk with moderate returns, such as debt funds.

[Read: Is Your Investment In Debt Mutual Fund At Risk?]

But the debacle of ILFS, followed by similar defaults in repayment by other top corporates, has led to a gargantuan credit crisis in debt mutual funds and an erosion of investors' principal. Simply because many fund houses had taken exposure to debt papers issued by these defaulters.

From these instances, investors learned valuable lessons:

What is considered to be safe, is not necessarily safe (Debt investments)
One has to prudently choose a worthy fund from a well-established fund house that follows robust investments process and systems

[Read: Can You Ignore Default And Liquidity Risk While Investing In Debt Mutual Funds?]

Since then, investors have become extremely cautious, investing only in mutual fund schemes that are from reputed and established industry players. Investors perceive these large fund houses to be safer and highly adept at managing their investments; hence they have invested heavily in debt funds offered from these fund houses, in order to preserve their capital. Specifically, in liquid and overnight funds, for these funds invest in debt instruments having a short maturity period.

A liquid fund invests in debt & money market instruments with a maturity of up to 91 days only. They invest in money market instruments such as Certificate of Deposits (CDs), Commercial Papers, Term Deposits, Call Money, Treasury Bills, and government securities, among others.

[Read: A 3-Step Guide to Building A Liquid And Secure Emergency Fund]

And overnight funds, one of the lesser-known categories of debt mutual funds, offers high liquidity by investing in overnight securities having a maturity of 1 business day. They invest in short-term security instruments including Tri-Party Repos (TREPS), Reverse Repos, and debt instruments with overnight maturity.

However, though liquid fund entails low risk, they are not absolutely safe. The performance of the liquid funds depends on the quality of debt papers and money market instruments they hold in the portfolio.

Particularly, the proportion of Commercial Papers (an unsecured negotiable money market instrument issued by corporates, primary dealers and all India Financial Institutions as an alternative source of short-term borrowings).

Whereas for an overnight fund, there is a reinvestment risk, i.e. overnight funds may not be able to reinvest their proceeds at the same rate of return, and that doesn't cause any capital erosion.

Among the two, investment risk involved for an overnight fund is least or almost zero and are more liquid.

[Read: Liquid Funds v/s Overnight Funds: Where To Park Your Short-Term Money?]

Hence, the investors decided to play safe and invest mostly in these two funds for a short term of say up to a year. The AMFI monthly data that was released validate this, which observed that there was a steady rise in number of folios, especially in Liquid funds and overnight funds.

Table1: Rise in number of folios of various categories of Debt funds

Open-ended Debt Schemes	Apr-19	May-19	Jun-19	Jul-19
Overnight Fund	21,363	22,149	23,588	25,332
Liquid Fund	1,451,293	1,493,220	1,573,737	1,608,355
Ultra-Short Duration Fund	591,392	606,796	616,149	625,353
Low Duration Fund	922,455	924,739	920,401	911,841
Money Market Fund	284,325	288,865	294,011	300,940
Short Duration Fund	263,140	267,690	270,692	275,579
Medium Duration Fund	243,389	236,775	231,738	227,819
Medium to Long Duration Fund	103,875	103,695	104,257	105,536
Long Duration Fund	18,687	18,851	19,721	22,181
Dynamic Bond Fund	212,622	210,439	209,773	210,881
Corporate Bond Fund	193,906	200,609	209,731	225,630
Credit Risk Fund	576,015	564,179	554,021	541,549
Banking and PSU Fund	84,669	87,682	91,470	98,344
Gilt Fund	64,848	68,296	74,039	83,926
Gilt Fund with 10 yr constant duration	10,400	11,937	14,543	19,014
Floater Fund	133,693	133,980	134,141	135,243

Data as of July 31, 2019
(Source: www.amfiindia.com)

Due to this, the average asset under management (AAUM) of liquid funds and overnight funds witnessed a surge of 8% and 40% respectively from April 2019 to July 2019.

Graph 1: Quarterly AAUM of top 10 industry players (Rs in Lakhs)

Data as of June 30, 2019
(Source: www.amfiindia.com)

Except for Reliance Mutual Fund, UTI Mutual Fund, and ICICI Prudential Mutual Fund, remaining top industry players have witnessed a good steady growth on a quarterly basis and within a year it rose by double-digit.

Table 2: Year over year growth in AAUM of top ten industry players

Fund House	April - June 2018- Q1 AAUM (Rs in Lakhs)	April - June 2019- Q1 AAUM (Rs in Lakhs)	yoy-growth (%)
HDFC Mutual Fund	30684072	36253843	18%
ICICI Prudential Mutual Fund	31016625	33728675	9%
SBI Mutual Fund	23311400	30753386	32%
Aditya Birla Sun Life Mutual Fund	24926992	25396526	2%
Reliance Mutual Fund	24044537	22257573	-7%
Kotak Mahindra Mutual Fund	12763523	16120906	26%
UTI Mutual Fund	15318313	15786586	3%
Franklin Templeton Mutual Fund	10441597	12496738	20%
Axis Mutual Fund	7920123	10222115	29%
IDFC Mutual Fund	6959051	8227912	18%

Data as of June 30, 2019
(Source: www.amfiindia.com)

This indicates that established players of the industry with robust investment systems in place have seen substantial growth in the form of an increase in investments due to the trust of investors, despite exposure to the credit crisis, debt markets facing liquidity crisis and slowdown in economy due to several macro and micro economic factors. What's augmented inflows is the market regulatory body's stringent actions to protect investors' interest, which are as follows:

Ban on upfront commission and new commission disclosure norms
Uniform fact sheets
Made mutual fund houses apply product labels with colour codes and risk-o-meter
Revised the expense ratio, bringing down the cost of investing
Introduction of Direct Plan for a mutual fund scheme
Categorization and Rationalization of Mutual Fund Schemes
Prudential norms governing liquid funds and other debt & money market instruments
Graded exit load for liquid funds
Changed valuation norms for below-investment grade securities
Open market operations
Asked mutual fund houses to shift all their investment to listed or to-be-listed equity and debt securities in a phased manner and reduce their exposure to unrated debt instruments from 25% to just 5%
And even pulled up credit rating agencies for their high laxity and enhanced their disclosure norms

[Read: Should The Rating Agencies Be Blamed For This Credit Crisis?]

Due to this, investors were encouraged to invest in debt funds, as it would enable transparency when effective implementation is complete and may even help eliminate systemic risk.

Since then, several fund houses are seizing this opportunity by launching overnight funds and liquid funds extensively to gather more AAUM. These funds primarily invest in a judicious mix of debt and money market instruments having a short duration of less than a year.

[Read: Why Your Money In Liquid Funds Is At Risk?]

Yes Mutual Fund (a new player) and PGIM India Mutual Fund have launched an overnight fund-YES Overnight Fund and PGIM India Overnight Fund.

The overnight fund is a category of debt scheme emerged after the SEBI's recategorization norms. As per the asset allocation also, both, YES Overnight Fund and PGIM India Overnight Fund can invest up to 100% of the portfolio into Debt Securities and Money Market Instruments with maturity on or before the next business day.

On the risk-return spectrum, overnight funds are placed lower because these carry the least amount of investment risk due to its investment into instruments of shortest investment duration of one day.

So, the overnight fund is a plausible choice as it provides better returns than bank FDs, are more liquid, and, at least, that doesn't cause any capital erosion.

But at the same time, the overnight funds generate returns, almost in line with general levels of interest rates and debt/money market conditions prevailing from time to time, i.e. in line with the repo rates and inter-bank lending rates in the overnight market, under normal conditions.

[Read: Are Mutual Fund Houses Right In Launching Overnight Funds Now?]

So, it is important, that one should be extremely careful while choosing a fund for investment. Investing in new funds makes less sense because it does not have a track record; especially when there are many funds available that have performed well within the category.

At the same time, one should select a worthy fund based on the evaluation of qualitative and quantitative parameters. These criteria accurately portray the fund's performance across market cycles and highlight the credibility of the fund house with processes and system in place.

Besides, don't forget your own investment time horizon and appetite for risk. If you have a time horizon of less than a month and want to keep your money safe, it's better to go with overnight funds. On the other hand, if you are willing to take a slightly higher credit risk for a better yield and can stay invested for at least three months, consider liquid fund.

[Read: The Best Liquid Funds For 2019]

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