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Debt funds going heavy on gilts

Aabhas Pandya

If you have parked your money with one of the large open-end debt funds of the Indian mutual fund industry, your investments might just be skating on thin ice. Faced with a deluge of fresh investments in the last one year, fund managers are faced with the arduous task of picking up quality instruments in the shallow debt market. In what clearly is a problem of plenty, the large-sized debt funds are now investing a large portion of their corpus in government securities (gilts or G-Secs). While investments in gilts takes care of the credit risk, it leaves the fund susceptible to interest rate volatility. This is where the danger lies for a retail investor, who does not understand the nuances of gilt investments but has put his moolah in 'risk-free' debt funds.

Investment in government securities is a double-edged sword. Since gilts are extremely liquid debt instruments, the entire investment in G-Secs is marked-to-market. While gilts generate phenomenal returns when interest rates are headed southwards, they rip through a fund's returns when interest rates take a U-turn. ''It's a tightrope walk for the fund manager since he has to strike the right balance between liquidity and interest rate risk, a high exposure to gilts being dangerous in the latter. A number of fund managers have, however, taken an aggressive exposure to gilts in the recent past in the absence of liquid corporate paper and to generate trading profits,'' says a debt fund manager.

Inflows have continued to be strong in debt funds in the last one year, despite the dazzling returns from equity funds. The combined unit capital of a sample of eight debt funds has vaulted by 195 per cent from Rs 17.55 billion to Rs 51.87 billion as on March 31, 2000. There are now seven open-end debt funds with a size of over Rs 7 billion with Prudential ICICI Income Plan managing the largest corpus of over Rs 18 billion. The seven debt funds, with an average size of Rs 11.50 billion, have invested around 40 per cent of the corpus in government securities. Barring SBI Mutual Fund, each of the AMCs has a 100 per cent gilt fund. This makes the medium-term debt funds akin to their diversified equity counterparts, which continue to hold a high exposure to ICE stocks despite dedicated technology funds.

Take, for instance, DSP Merrill Lynch Bond Fund with a size of Rs 10.22 billion as on April 28, 2000. The fund has put almost 50 per cent of its assets in G-Secs. Prudential-ICICI has also invested 30 per cent or Rs 5.50 billion of its corpus in G-Secs. The only exception to this investment trend is Birla Income Plus, which has put only 16 per cent of its assets in gilts. Fund managers have also been parking money in gilts as they wait for quality corporate paper to hit the market. The slack pace of economic activity in the country added to their woes since it has affected the float of debt issues in the primary market.

''The constraints of managing a large debt fund are manifold, with the biggest of them being finding quality assets,'' says Parijat Agarwal, fund manager with Sun F&C Asset Management Company. Parijat was managing the Rs 10-billion UTI Bond Fund before he joined Sun F&C. ''The lack of corporate papers essentially means investing a bigger portion of the portfolio (30-40 per cent) in government securities. This makes the returns quite volatile,'' he points out. Adds Nilesh Shah at Templeton, ''Managing liquidity risk is a problem, as, in a large fund, you tend to have higher inflow and outflows emanating mainly from the corporate investors as witnessed in March this year.'' The concern on the liquidity front also explains the higher exposure to government securities, since it is easier to liquidate gilts to generate cash in the event of redemption.

Fund	Size in Rs crore on April 28	% of assets in gilts on April 28
Alliance Liquid Income (G)	857.06	56
Birla Income Plus (G)	1708.73	16
DSPML Bond (G)	1021.90	47
Magnum LIF (G)	739.00	40
Pru ICICI Income Plan (G)	1819.93	30
Templeton India Income (G)	893.82	52

Source: Value Research

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