Rs. 1.6 trillion risk hanging over debt funds

Amandeep Chopra

Group President & Head – Fixed Income


  • The recent downgrade of JRPIC (an SPV with the Jharkhand Govt) has raised questions on the sanctity of SPV structures which were thought to be ring-fenced, thus putting under risk infrastructure debt of over Rs.1.6 trillion, in which debt funds are significant owners. Amandeep hopes the NCLAT bench hearing will provide clarity soon on this issue, and pending this, one should treat this as a one-off event and not a systemic issue.
  • Amandeep believes the new side pocketing rules, while good for investors, raise many operational issues. Being prudent on credit is anyway the best option, says Amandeep.
  • Real rates are very attractive today and Amandeep strongly urges investors to build fixed income portfolios with a judicious mix of accrual and duration based funds.

WF: The downgrade of JRPIC (the IL&FS and Jharkhand Govt SPV) is seen by some experts (Click here) as a cause for serious concern for debt markets in general and debt funds in particular, given the affinity that debt funds have towards SPV structures and the implicit comfort derived from such structures. What is your take on broader implications of this default/downgrade?

Amandeep: SPVs have a ring fenced mechanism, which ensures that the cash generated goes to the lender even when the parent goes into some trouble. Failure to adhere to such structures, which are critical for long-term infrastructure financing, could stall future funding not only to infrastructure sector but can also jeopardise legal sanctity of all the ring fenced structures such as securitised debt, pooled transmission receivables etc. As per one of the rating agencies, infrastructure SPV debt of over Rs. 1.6 trillion would come under risk and efficacy of such structure would be questioned.

WF: Should we be concerned about asset quality of securitized paper and/or SPV structures that the fund industry owns in its debt funds? How can distributors figure out which portfolios carry higher risk, when credit ratings slip several notches within a week?

Amandeep: This whole issue of downgrade has stemmed more from a legal perspective and not a credit perspective. The SPV structure follows a ring-fenced mechanism wherein the borrower deposits the annuities in an Escrow account and this account is monitored by the lender or a trustee appointed by the lenders and withdrawals from the account are allowed only after the consent of the lender or the trustee. This incident is one off case which has raised questions on sanctity of ring-fencing mechanism. The NCLAT bench hearing would provide some clarity on the issue. We believe, this is an one off event and distributor/ investors should not panic and exit from the schemes which have taken exposure to SPVs unless there is a financial requirement.

WF: To what extent do you actually see the new side pocket rules for debt funds being used by the industry? Do you see this facility enabling more calculated risk taking among credit fund managers?

Amandeep: From an investor’s perspective, side pocketing is a positive step taken by SEBI. In case a credit event happens and an investor has taken a hit, side pocketing would enable the investors to take the benefit if a recovery happens at a future date. However, to implement the side pocketing rule, the schemes will have to undergo the process of change in fundamental attributes which is a cost and time consuming effort. That said, there are certain parameters which are to be evaluated viz. taxation aspects of two different NAVs, if multiple papers are downgraded how many side pockets would get created etc. SEBI has put measures in place wherein fund manager’s performance incentives could be negatively impacted if side pocketing is misused. We believe fund manager would continue to be prudent while selecting an instrument. At UTI Mutual Funds, we have a dedicated research team and a robust credit evaluation process in place wherein the analysts does a comprehensive analysis of an entity and comes up with an internal rating, based on which the fund manager decides to take an exposure in the instrument.

WF: What are the biggest lessons to be learnt from 2018’s bond market volatility and credit accidents?

Amandeep: The year 2018 was like a roller coaster ride for global and domestic debt markets. The year began on a volatile note with rising interest rates, elevated crude oil prices, geopolitical tensions and subdued investor demand for emerging markets. This was further aided by a declining set of macro numbers and liquidity for India. While we saw the peak and bottom of oil, INR and 10 year yields reflected the domestic factors and closed at levels higher at year end. 2019 is beginning with some of the key concerns of 2018 having moderated to a large extent. On the credit front, the default of IL & FS was a systemic event and raised a lot of questions around rating agencies. Despite their expertise and access to information, they were not able to red flag the concerns. The upheaval in the credit space reiterates the need for MFs to weigh the risk-reward trade off before taking an exposure. At UTI MF the investment philosophy is to deliver superior risk adjusted return and not chase YTM by taking substantial exposure in low rated (A+ and below) instruments.

WF: What is your outlook on inflation and interest rates over the next 12 months and what are likely to be the key drivers?

Amandeep: Having seen the worst of oil prices, domestic inflation, currency depreciation and the 10 year yields, the markets are heaving a sigh of relief and appear to be consolidating. The initial trends appear to favor an environment that could be supportive for interest rate outlook. Global growth appears to be moderating and has impacted commodity outlook and expectations of further tightening from the developed economy central banks. Slowing US growth and fewer rate hikes in 2019 from the US Federal Reserve are expected to keep US treasuries and US $ subdued. This is positive for the Indian currency and inflation outlook. If oil remains range bound without any sharp spikes like the last year then it allows economy to adjust with positive trends for macro factors like CAD, inflation, INR and sentiment of international investors. However, in the near term markets are expected to react to the newsflow in the run-up to the elections. The election results would be a key event that would be tracked by market participants.

We believe that in the current circumstances as inflation eases in the first half of 2019 and remains anchored around RBI's medium term target in second half, there is a case for RBI to change its policy stance and a small possibility of a cut in rates. However, a lot will depend on how CPI shapes up in the second half. Our current estimates indicate a risk of a V-shaped trajectory with it likely exceeding 4.2% in the second half. Thus a clear case for anything more than a very shallow rate easing cycle is not visible to us at present, provided all the pieces fall in place.

WF: How are you calibrating your strategies in the accrual and duration spaces in the current market environment?

Amandeep: We believe the near term outlook is likely to be subdued as multiple factors on both global and domestic front viz. oil prices, currency depreciation, domestic inflation, election results, fiscal numbers etc. would be at play and are likely to keep markets on edge. We do not expect RBI to aggressively ease its monetary policy. We would wait and watch how the above mentioned factors pan out. Given our outlook on rates, we continue to remain neutral and maintain low duration across our funds. However, if opportunity presents we would tactically add duration to our funds.

WF: Where do you see the best opportunities today in the fixed income market?

Amandeep: Presently the real rates are very attractive for investing in fixed income funds. Investors can build a fixed income portfolio by investing in funds having a combination of income accrual and short term duration like the UTI Short-Term Fund, UTI PSU & Banking PSU Fund and UTI Corporate Bond Fund. Conservative investors can also look at high quality Fixed Maturity Plans to capture the ongoing rates by investing for a 3 year period. We think investors should not shy away from taking a moderate risk by allocating a small portion of their portfolio to UTI Credit Risk Funds, which has a very minimal exposure to low rated (A rated and below) and unrated papers.

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