What the debt news means to you
Updated: Feb 27, 2020
“Do you think I should stop investing in debt mutual funds”,
“ Should I withdraw all my money from mutual funds?”,
“Mutual funds are not sahi”
These are some of the comments and questions I as a financial advisor have been receiving in the recent past.
If you invest in mutual funds or even generally follow the news, the DHFL crisis is a hard one to miss. Before we get talking about what happened, let’s first understand what debt funds are.
As the name suggests, debt is when you are lending money to an organization and receive interest on the loan you are giving. So, debt funds are mutual fund schemes that invest in money market instruments such as corporate bonds, treasury bills, government securities and commercial papers. Since these instruments are relatively safer, the risk of loss reduces as compared to the same investment in equity funds. I am going to take a moment to familiarise you with Dewan Housing Finance Limited(DHFL) itself, this wound just won’t stop bleeding and since it is the most talked-about situation let me explain.
Debt funds and DHFL crisis
DHFL was established to enable access to affordable housing finance to the lower and middle-income groups in semi-urban and rural parts of India. DHFL is the second housing finance company to be established in the country. The company also leases commercial and residential premises. DHFL is among the 50 biggest financial companies in India.
To simplify this in English, this means it doesn’t have a banking licence or access to central bank liquidity, but is nevertheless involved in financial services – in this case, primarily giving loans to home buyers in India’s tier 2 and tier 3 cities.
The funding models of housing finance companies and Non-Banking Financial Company(NBFC) loan companies, which have become increasingly reliant on short-term instruments to fund longer-term assets, have been particularly affected by the liquidity squeeze. One reason believed to be the root cause of troubles at DHFL and other NBFCs is their business model.
While they borrowed short-term funds through the commercial debt and commercial paper market, they lent long-term to home loan borrowers and to the construction sector. In other words, NBFCs borrowed money in ways structured for the short term but gave loans out for the long term. When the loans to NBFCs began to be impacted they suffered from cash flow and in turn impacted their performance as a company and by extension, the investments made in them by organisations and individuals.
Why should I, the investor be worried?
No, you shouldn’t be. If you make use of the right methods and tools when investing. When investing in a mutual fund, always ensure you choose the right financial advisor. This case in point is just one of the many reasons why. Companies that are solid in their research stood strong against what happened with DHFL and had little or no effect on the investments of their customers.
Companies like DHFL are rated by rating agencies such as CRISIL (Credit Rating Information Services of India Limited, a global analytical company providing ratings, research, and risk and policy advisory services.)and in the recent past, CRISIL downgraded DHFL to a “D” / default grade.
Investment companies that have strong research do not wait for such events to happen to manage customer portfolios, they pick up the hints in the market early and make changes if required. Coming to the part of investing in debt funds, I still think one should continue investing in them as long as you are being advised by the right financial advisor or platform who are thorough in their research.