Higher YTM does not necessarily mean higher return
Senior Fund Manager
ICICI Prudential AMC
WF: Risks associated with credit risk funds have been under focus, especially post the IL&FS issue. What is the key lesson for the mutual fund industry here?
Manish: Risk is an integral part of investing. Credit investments primarily carry three unique risks: credit risk, concentration risk (i.e. the quantum of risk one is taking against one promoter or company) and liquidity risk since some corporate bonds are not as liquid as others. It is critical for fund managers and advisors to keep a keen eye on all of these risks. Credit as an asset class has emerged only in the last few years so perhaps the learning curve is comparatively at a nascent stage as compared to fixed income or duration products.
Therefore, we have been continuously advocating the importance of managing those risks through prudent risk management steps. As a fund house, none of our credits have been under stress through the past month. So, the lesson for the fund managers is to be follow the best practices, undertake the required due diligences such that the investors have a good investment experience.
WF: Credit risk funds always had a structural issue of lower level of liquidity for the underlying securities in the portfolio. Is it time to periodically determine and publish liquidity stress test results for credit risk fund portfolios?
Manish: At ICICI Prudential AMC, we ensure there is adequate liquidity on the asset side. In case of liabilities, given the nature of the scheme, we maintain a very retail profile so that portfolio flows are more consistent and sticky. Amidst all the noise around this category last month, we still managed to attract inflows in this category of fund.
All debt investments made by the schemes of ICICI Prudential Mutual Fund are carried out in accordance with the Debt Investment Policy, approved by our Board of Trustees. The Policy outlines our credit evaluation process which focuses on achieving the objectives of safety, liquidity and return. It factors in the investor profile and their risk appetite to meet scheme-specific investment objectives. Investments are made only after appropriate due-diligence and with requisite credit approvals. The due-diligence process involves appraisal of the investee company with a focus on assessment of the issuer's willingness and ability to service the debt on time, based on an analysis of business and financial risks involved. The Policy also outlines issuer selection criteria and maximum permissible investment limits for various issuer types. In addition, the Policy stipulates the approval authority matrix and specifies the review and monitoring requirement for debt investments.
WF: In credit risk funds, portfolio’s YTMs have always been used as a proxy of likely returns in most conversations with investors. Do you think this conversation needs to change?
Manish: The conversation around credit risk fund for us has always been about risk adjusted returns and not YTMs.
WF: What parameters should distributors evaluate when considering different credit risk funds and how should these parameters be best evaluated?
Manish: As a distributor, when looking at a portfolio, it is important to understand the nature the three different risks: credit risk, concentration risk and liquidity risk – that the portfolio is likely to face. Secondly, one should look for risk adjusted return. Higher YTM does not necessarily mean higher return. Taking higher amount of risk for an extra 1% can prove to be detrimental at times. Hence, our endeavour always has been to create portfolios which can generate better risk adjusted return for the investors.
WF: Some experts have called for fund houses to publish their internal credit rating for instruments in their portfolio, in addition to rating agencies’ ratings. This, it is believed, will give a better picture of the risk level that fund managers are willing to take in their portfolios – which is vital information for distributors and investors when evaluating funds for investment. Do you support this observation?
Manish: As a fund house when we do our own due diligence and research, we pick up assets at a price and at a risk level which is in line and well within the framework of our philosophy of own risk management practices. While the rating agencies do give out their ratings which acts as a starting point for our internal analysis; but ultimately as a fund house we have our own internal analysis. For distributors and investors, what is important is to concentrate and understand the process followed by a fund house, their approach to credit and risk management systems rather than just the ratings aspect.
WF: What is the investment argument for ICICI Prudential Credit Risk Fund vis-à-vis ICICI Prudential Corporate Bond Fund that invest only in high grade securities, given the incremental level of risk involved? Should credit risk funds continue as the flagship retail offering for fund houses or should we focus more on corporate bond funds at the very retail level?
Manish: Both the schemes have different mandate. Corporate bond fund predominantly invests in AA+ and above rated instruments while credit risk fund invests in assets which as rated AA or lower. The return profiles of the two schemes are also different given that AA+ corporate trade at much lower yields compared to AA and A assets. So, both the products could find value in investor’s overall portfolios depending on an individual’s risk profile.
Riskometer & Disclaimer
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