Many of us invest in debt mutual funds and think they are safe. However, recent events have led us, by definition, to invest in debt funds themselves.
As you may know, debt securities were now riskier than equity funds. Because with equity funds, there is hope that the market will rise in the future and that we will achieve a reasonable return even if the market falls. With debt funds, however, in many cases this is a permanent loss for investors.
Debt Mutual Funds – Truths Mutual Fund Companies didn’t tell you
Now let’s understand the certain truths that neither mutual fund companies nor SEBI have forced to tell you (the investors).
# The definition of SEBI for debt mutual funds does not contain any information about CREDIT or DEFAULT RISK
If you look at SEBI’s definition of debt mutual funds, only the Macaulay duration of the portfolio is shown. It does not indicate the quality of the underlying securities that the fund manager must hold in relation to each category of the fund (with the exception of the credit risk fund).
We all think liquid funds are safe and best in the short term, don’t we? At the same time, long-term bond funds are risky. In both cases, however, the SEBI definition of funds does not contain any information on CREDIT QUALITY.
The definition of liquid fund is “investment in debt securities and money market paper with a term of only up to 91 days”.
The Long Duration Fund is “Investing in debt and money market instruments so that the Macaulay duration of the portfolio is more than 7 years”.
If you notice the definitions, it is clear that SEBI simply classifies the funds according to the duration but not the quality of the securities.
Therefore, fund managers have the freedom to choose the quality of the paper according to their desire to generate a certain alpha against the index or peers.
That is exactly what happened to the Franklin fiasco. This particular AMC invested in high-risk, low-rated bonds, whether ultra short term or short term, and only managed the SEBI definition.
By definition, we assume that liquid funds are safest and ultra-short, short-term or long-term funds are riskier. However, the fund manager has the same freedom to choose low-rated securities (of course, only to match the term), regardless of whether they are liquid funds or long-term bond funds.
Suppose a fund claims that it ONLY invests in high-rated securities or government securities. This is based on his choice, but not on regulatory requirements. Therefore, we need rules on debt securities where the regulator is clear about each category of the fund and how much risk the fund manager can take on the quality of the paper.
# General definition of DURATION
If you look again at the definitions of the same two categories of debt that I explained above, you will see that SEBI defines the funds based on Macaulay’s term. How many debt investors understand that?
Macaulay Duration – This is the weighted AVERAGE MATURITY of the cash flows from the bond.
If you really want to be informed in detail about the macula duration, watch the following video.
But keep in mind that it’s average. So, if we remember the quote from the famous book “Unveiling the Myth of Retirement,” on average, it is not applicable to individuals.
Franklin did that too. If you see Disclosure of Franklin Templeton India With regard to the 6 closed funds and the approximate schedule of when you get the money back, you can see it clearly.
Let’s take an example of the Ultra Short Term Debt Fund. According to SEBI, the definition of the Ultra Short Term Debt Fund is “Investing in debt & money market instruments so that the portfolio’s Macaulay duration is in between
3 months – 6 months ”. But you see the timeline of the cash flow you receive from the Franklin Templeton Ultra Short Fund in a completely different way.
In particular, take a look at what they define in terms of the Macaulay duration of the Ultra Short Bond Fund. I will share the same to your advantage.
Q-If the Macaulay duration of the Ultra Short Bond Fund is only 4.53 months, why does it take you almost 2 years to return a substantial percentage of the money in this fund?
A3: The Macaulay duration reflects the average duration of the bonds held in the portfolio and the expected cash flows of the bond. A portfolio typically has an average maturity that is slightly longer than the Macaulay duration. For example, in the Ultra Short Bond Fund, a Macaulay duration of 4.53 months means that the portfolio has an average maturity of 5.27 months. In the broadest sense, this indicates that this is the center of the maturity dates for the bonds held in the portfolio and not the time for the last maturity in the portfolio. Accordingly, you will find that with a Macaulay duration of 4.53 months, the fund should be able to generate a return of around 50% in the first year and substantial money in two years.
For securities whose interest rates are reset at regular intervals and whose minimum and upper limits are set in accordance with the issue conditions, the due date for the cash flow forecasts compared to the interest rate reset date that is normally taken into account was taken into account in Macaulay duration and valuation by the valuation agencies. In addition, this cash flow takes into account the fact that the cash flows initially received will be used to pay for the borrowing in the Fund, which will delay the delay with which the systems can begin to return funds to shareholders. It can also be noted that these calculations are conservative and do not take sales or prepayments or coupon payments into account. Systems will strive to accelerate these payments by actively seeking advance payments and opportunities in the market while maintaining value for shareholders.
Many retail investors have the misconception that the fund manager gets all of his money back within 3-6 months when investing in ultra short term debt funds, as the definition also stipulates the same in accordance with SEBI.
But the reality is very different. Don’t think this is the case with Franklin Templeton India Funds. This is the reality regarding all AMCs and all debt instruments.
For this reason, YOU CANNOT ALIGN YOUR DURATION WITH PORTFOLIO’S FUNDING DURATION. Many of us invest in Ultra Short Term Debt Funds and think that this is for SHORT TIME. In reality, the picture can be completely different.
Conclusion: – These are the two greatest truths that many private investors and indeed the Brotherhood of Advisors do not know. We invest blindly and bear the pain later. Be careful when investing in debt, e.g. B. How to be more careful with equity funds (in fact, you need to be more careful).
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