Tuesday, December 9, 2008

Small debt funds face concentration risk: CRISIL

CRISIL`s analysis reveals that the portfolio credit quality of most Indian debt mutual fund schemes is strong. However, a majority of schemes have single-industry concentration, and many small schemes have single-company concentration. Funds with large and illiquid single-company exposures could be affected by redemption pressure: single-company exposures could increase as these funds sell the more liquid assets in their portfolios to meet redemptions. The high credit quality of most debt funds` investments, though, partly offsets the risks arising from concentrated holdings.
The 860 schemes analyzed cover 96% of the assets under management (AUM) of Indian debt mutual funds; gilt schemes are excluded, since they do not have sector or company exposure. Investments that are rated `AAA` and `P1+`, the highest rating categories, constitute 82% of the portfolios analyzed for the study; the `AA` category adds another 6% to this figure.
``Most debt funds have not compromised on credit quality in search of returns, and investors therefore have little reason to fear defaults eroding the value of their investments. Nevertheless, lack of adequate portfolio diversification does remain an issue,`` said Roopa Kudva, managing director and chief executive officer, CRISIL.
A concentrated portfolio increases the risk of investors losing a large chunk of their capital in the event of a single default. CRISIL has defined portfolios where more than 25% of AUM is exposed to a single industry or company as `significantly exposed`. By this definition, almost all debt schemes have significant exposure to at least one sector. Half of the schemes have a significant exposure to the banking sector, and 38% have a significant exposure to the non-bank financial company (NBFC) sector. Contrary to widespread perception, exposure to the real estate sector is relatively low.
``We estimate that only 5% of debt mutual funds` AUM consists of real estate sector debt. More importantly, not more than 3% of debt mutual funds have significant exposure to the real estate sector,`` said Tarun Bhatia, head, financial sector ratings, CRISIL.
More risky than single-industry exposure is single-company exposure, because it implies even lower diversity. Of the 58 debt schemes that have AUMs of Rs 10 billion and above, only two are significantly exposed to single companies. However, of the remaining 802 schemes in the study, 249 have significant exposure to at least one company. This means that, while the larger schemes are well diversified as far as single-company exposure is concerned, 30% of the smaller schemes have significant single-company exposure.
These concentration levels reflect the limited investment opportunities in the Indian debt market. Most funds have worked towards mitigating concentration risk by investing in highly-rated credits as the rating distribution statistics above indicate.
``Over the longer term, the solution to concentration risk lies in having a more vibrant debt market with a much wider issuer base than exists in the country today,`` Kudva added.

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