After the IL&FS bond downgrade, it should be clear to all debt mutual fund investors that a high credit rating does not mean much. Even a small degrade will affect the NAV. While I am firm of the opinion that such credit risk NAV falls are part and parcel of debt mutual fund investing, many investors want investment options with little or no credit risk. We discuss some liquid funds with low credit risk options in this post.
Prior to the SEBI categorization of mutual funds, there were a few short-term gilt funds. In particular, DSP (then + Blackrock) had a gilt fund with a mandate to invest only in sovereign bonds that matured within a year. Both the fund and the category were among the first casualties of the recategorization: Death of a good mutual fund: DSP BlackRock Treasury Bill Fund. The advantage here was the absence of credit risk.
So the question now is, can we now select a liquid fund with zero or minimal credit risk? The answer is a yes but with terms and conditions applicable. We will understand why this is so as we explore the options.
Assumptions: You are looking for a liquid fund. You cannot stomach credit risk. That is, you do not want the credit rating of the bonds in your fund to be degraded (or upgraded!). You are willing to sacrifice returns in exchange for your requirement.
General thumb rules
1: Never ever chase 5-star rated liquid funds or any debt fund. That is a dumb thing to do. Want proof? This is a snapshot of Taurus Liquid Fund from Value Research.
That looks awesome is it not? A 5-star fund with smooth NAV growth wow! This is over the last 1Y. Now click on the 3Y button on the graph and you get:
This is because: Taurus Debt Mutual Funds Crash Due to Ballarpur Bond Downgrade Star rating fans should go and ask VR why this fund is a 5-star fund! Well, the reason is that VR ranks debt funds based on their last 18-month performance and if you look at the last 18 months for this fund:
Star ratings are dumb. They do not, well they cannot factor unseen risks like credit risks. If you must use star ratings for shortlisting funds, select 1-star, 2-star or at max 3-star funds. They will typically* have lower ratings because they did not take on credit risk
* funds that took on credit risk and paid the price will be temporarily relegated to 1-star until all is forgiven as above.
2: Debt mutual funds are problematic creatures. Sometimes one will have to keep an eye on their portfolio. I hate this. I am not paying money to the fund manager for me to keep an eye. Unfortunately, except for the first option below, you may need to occasionally keep an eye on the fund portfolio (I don’t, but you may want to).
liquid funds with low credit risk
1 Overnight mutual funds
A liquid fund can invest in bonds that mature within 91 days. If you want to minimise all kinds of risk, then stick to overnight mutual funds. These invest in bonds that mature in a day! Read more: Worried about risk in debt mutual funds? Park your money in overnight mutual funds
2 Reliance ETF Liquid BEES
We live in interesting times! Liquid Bees (first owned by Goldman Sachs) was the only liquid ETF for 15Y! There are now options from DSP (just started) and ICICI (yet to start). However, ignore those and stick to liquid bees if you want an ETF with minimal credit risk
This ETF will invest in: (source scheme document)
CBLO/Repo & Reverse Repo predominantly and other money market instruments.
What is CBLO? CBLO or Collateralised Lending & Borrowing Obligation
• Is an RBI-approved Money Market Instrument;
• Is an instrument backed by Gilts as collaterals;
• Creates an obligation on the borrower to repay the money borrowed along with interest on a predetermined future date;
• A right and authority to the lender to receive money lent along with interest on a predetermined future date;
• Creates a charge on the collaterals deposited by the borrower with CCIL for the purpose.
What is Repo and Reverse Repo?
‘Repo’ means the sale of Government Securities with simultaneous agreement to repurchase them at a later date. ‘Reverse Repo’ means purchase
of Government Securities with simultaneous agreement to resell them at a later date.
What is Call Money? Call Money forms an important segment of the Indian money market segment. Call Money means funds transacted on an overnight basis.
Cons of Liquid Bees
- Demat account is required
- The fund will declare a daily dividend and this will incur a dividend distribution tax (29.12%). These dividends will be reinvested into the fund mandatorily once a month. So this will affect returns but these dividends also reduce some risk due to profit booking
- Suitable only for those in 30% slab
- There can temporary price and nav differences (although small) and can lower returns if sold or purchased during such times.
- Will not beat a fixed deposit (then again a liquid fund should not beat a fixed deposit. It should only beat a normal savings bank account).
- It aspires to beat only the NIFTY 1D Rate Index. This is an overnight bond benchmark and typically will return lower than CRISIL Liquid – the usual liquid fund benchmark.
Pros of Liquid Bees
- Because of daily dividends, the NAV of the fund will not change from day to day and so the capital gains will be absent.
- I think its portfolio is suitable for those scared of credit risk and in such a case, the pros outweigh the cons.
- Best suited for stock investors who like to sit on cash and quickly shift from cash to stocks when the opportunity is “right”
Now, the rest of the options are not so clear-cut and you will have to invest based on trust. That is, they will/can take on credit risk. So if you are so worried about risk, you should stay away. However, I think it is quite okay to take a reasonable risk with these funds.
First, let us consider Quantum Liquid Fund. I use this and this is part of My Handpicked Mutual Funds September 2018 (PlumbLine). However, it can and does invest in corporate bonds. This does not fit into the low-credit risk box but I I trust Quantum to be a responsible AMC.
I have been looking at other liquid funds and it is not easy to find a liquid fund with low credit risk. The following are reasonable choices:
Parag Parikh Liquid Fund
Thanks to Pritam for pointing this out. Currently, it holds a good amount of cash and sovereign bonds. Please note that it can hold significant amounts of commercial paper. So do not assume this has low credit risk. The fund is still too young for us to expect it to stick to a pattern.
ICICI Liquid Fund has a good track record and has the largest AUM. This can invest in commercial paper and hence there will be a credit risk. If you trust the fund management, then you can consider this. At least they do not have to chase AUM by investing in risky bonds.
HDFC Liquid Fund all of the above arguments also apply to this fund.
The big advantage with large AUM is that the no of securities will ve pretty high. For example, HDFC Liquid has 165 securities and ICICI Liquid, 192. This means concentration risk in a single bond will be quite low (< 5%). So even if one is degraded, the hit will not be huge.
On Mirae Cash Management, it has been part of IL&FS fiasco due to its holding in IL&FS securities .. though this bond matured in 10th September and they were paid in full , so they were lucky to come out of the woods.
Such things are going to happen with most funds. As long as the individual exposures are small, it should be okay.
I am sure there are other good funds from other AMCs. I think it is best to keep an eye on the portfolio from time to time if not each month. You do not have to study each bond in the portfolio, but just if the AMC has increase exposure a bit too much in any bond. If so, check if that is from a well-known trustworthy issuer. This increase in exposure risk will be higher in lower AUM funds.
In summary either stick to overnight funds to liquid bees ETFs if you cannot stomach credit risk. Else, either buy large AUM funds from the bigwig AMCs or from AMCs that you perceive as responsible. Ultimately it will boil down to an opinion. Ultimately it will boil down to a leap of faith if you want to do better than the overnight funds! Ultimately you will have to understand that higher returns will mean higher risk.