MUMBAI: Amid increasing repayment pressure in debt programs, mutual funds are making big changes in their asset allocation towards stronger borrowers to mitigate risk.
Driven by the decline in assets under management (AUM) as well as by risk aversion and regulation, UCITS reduced the exposure to the debt of non-bank finance companies and housing finance companies, by 45% decrease, compared to the peak of July-August 2018, with even more marked cuts, down 90%, on real estate financing entities, developer financing, etc., which are reduced to 1.5 % of outstanding mutual fund debt, Morgan Stanley said in an April 27 report.
Investments in mutual fund debt in non-bank financial corporations (NBFCs) and housing finance companies (HFCs) were significant, particularly in FY14 through the first half of the fiscal year 19. Mutual fund debt assets under management, after growing rapidly in FY15-first half of FY19, have stagnated and declined since August 2018 – down 14% year-on-year from August 2018 to March 2020.
Morgan Stanley believes that further downside risks to mutual fund exposure to the NBFC and HFC segments are contained. Based on a sample of over 25 NBFCs / HFCs, funds in all borrowings increased from 18% in September 2018 to 12% as of December 19. On the other hand, for entities facing funding constraints, it drops more sharply, from 28% to 6%.
“A potential funding risk for the NBFC segment is that mutual funds see accelerated debt outflows. As the NBFC / HFC segment’s reliance on mutual funds has diminished, such potential exits would coincide with banks’ risk aversion to NBFCs after supporting the segment for the past 18 months, ” Morgan Stanley said.
According to estimates from the global foreign brokerage firm, mutual fund debt investments in NBFCs / HFCs, as well as maturities over the next 12 months with strong parentage, account for more than 80%. Lenders facing funding constraints of any kind account for 5% of the global mutual debt exposure to NBFCs and HFCs. Credit risk funds, which are susceptible to redemption pressures, make up 5% of all mutual fund assets under management, he said.
While the debt mutual fund industry had benefited from the sharp rise in financial savings after demonetization in the December 2016 quarter, the industry’s asset under management growth reached 50% year-on-year. However, there have been repeated shocks from credit events, starting with the IL&FS crisis in September 2018 and followed by several other business failures. The last crisis was that of Franklin Templeton who closed its six debt programs, the RBI having mobilized to provide a window of liquidity through the banking system.
Emkay Global Financial Services analysts believe that recent events could affect flows to debt funds and that there have been major changes in the investment strategies of debt funds after the IL&FS crisis. He said risk aversion was visible in the rating profile of instruments held by debt funds, while the share of corporate papers rated below AAA fell from 41% of pre-IL & FS AUMs to 22% now. In absolute terms, this is a 30% drop in the total holdings of these securities that are less well rated by bond MFs.
He said holdings of government securities (GSec) and public sector corporate bonds (PSU) have risen sharply from 24% of AUMs to 40% now. As a result, private sector firms’ MF holdings fell 22%, with private NBFCs experiencing a steeper drop of 42% and commercial papers dropping from 39% of industry assets under management to 21% now.
“This happened despite the ratio of liquid funds and other short-term funds in the industry’s assets under management remained stable throughout this period, suggesting that this shift is motivated more by a shift asset maturity decision by fund managers (and paper supply) than a behavior induced by the mix of inflows on different maturity bands. There has been a cautious shift in the quality of the paper held, with the sub-AAA share of the portfolio falling from 41% to 22%, showing a decrease of 30% in absolute terms, ”said analysts at Emkay Global Financial Services Ltd.
He believes that these trends will only continue and strengthen after recent events.
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