Debt mutual fund checklist

Debt funds are recently being hit hard with companies like IL&FS, DHFL, Essel group, etc. defaulting on papers. This may have made investors rethink about investing in debt funds. Though most of the AUM (Asset Under Management) in debt funds come from institutional investors and HNIs (High Networth Individuals), retail investor's contribution towards debt funds must not be ignored. So, what are the things that investors of debt funds must check before investing in it.

Exposure to low-rated bonds
This is one of the things that investors must check in debt funds before investing. Low-rated bonds are those which are below BBB rated. The thing to remember here is different rating agencies have different ratings. Low rate bonds or papers are risky. Debt funds can invest in them with proper underwriting procedures to generate returns, but must not have high exposure to them. Credit risk funds usually have exposure to low-rated bonds.

Exposure to papers of one issuer
This is more sort of diversification risk. As rightly said, “Don’t put all eggs in one basket”. This not only applies to stocks and equity funds but also to debt funds. So, exposure to papers of a single issuer or even you can say a single group can increase the risk that the funds carry. During the episode of IL&FS, DHFL, Essel group, etc. this was one of the issues which affected debt funds.

Lending against shares
This was also one of the issues that affected the debt funds. This happened specifically in the case of Essel group wherein the shares were pledged as collateral for loans. The company needs to pledge shares worth 1.5 to 2 times of lending amount and needs to maintain the same. In case, the same is not maintained then the lender (here, debt funds) can sell the shares in the market and recover the amount. However, funds with high exposure to such a setup may prove to be risky.