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Debt Mutual Funds More Safe More Diversified

Last week, SEBI announced the revised prudential limits on investments by the debt mutual funds.

The objective is to make them "more safe" and "more diversified".

These new limits were triggered by the scare last year, when a couple of debt schemes managed by J P Morgan AMC were temporarily in trouble as one company (Amtek Auto) in their portfolio defaulted.

Therefore, various exposure limits by debt mutual funds have been revised, with a view to

a. Minimize the risk to the overall scheme, in case of any particular company's credit downgrade or default

b. Enable the mutual funds to withstand the shocks of any adverse credit events

c. Provide enhanced diversification to the risk-averse debt mutual fund investors

You can trust SEBI to keep your debt mutual funds safe and secure.

New prudential limits — at company, group and sector level — are detailed below.

1. Investment by a debt mutual fund scheme, to a single issuing company, would be restricted to a maximum of 10%. Earlier this limit was 15%. This can be enhanced by another 2% (earlier 5%), subject to the approval by the trustees. 

2. Single sector exposure stands reduced to 25% of the NAV, from 30% earlier.

3. Total exposure to a single group shall be limited to 20% of the NAV. This can be increased to 25% if approved by the trustees.

[Group includes the company, its subsidiaries, fellow subsidiaries, holding company and its associates. However, all Government owned PSU entities, PFI & PSU banks will be excluded from group level limits.]

4. Exposure to Housing Finance Companies has been brought down to 5% of NAV; from 10% earlier.

5. Trustees must review such company, sector and group level exposures, across all the schemes and confirm the compliance to SEBI in the half-yearly trustee report.

6. The abovementioned limits shall apply on all fresh investments by any new / existing scheme. Asset Management Companies would be given appropriate time to conform to these new prudential limits.

As I have often stated, SEBI (Securities and Exchange Board of India) and AMFI (Association of Mutual Funds in India) have been admirably monitoring and regulating the mutual fund industry in India. By virtue of this, Indian mutual fund industry is undeniably the best in the world.

Handsome performance delivered over the last two decades, within minimal transgressions, is an ample proof of this.

This makes mutual funds absolutely the best investment for a retail investor in India.

With regards to the debt mutual funds, How To Earn Tax-Free Risk-Free Income would be an eye-opener for many.

By the way, the J P Morgan AMC-Amtek Auto issue demonstrated the benefits of investing through the mutual funds. 

Suppose Rs.1 lakh was invested directly into the Amtek Auto debentures, bonds or fixed deposits. Then, upon default, the investor would stand to lose the entire Rs.1 lakh.

Whereas a mutual fund investor, who invested Rs.1 lakh in the 'troubled' J P Morgan AMC debt schemes, would probably suffer only a minor erosion in his capital. Because of the diversified portfolio, major portion of his capital would be quite safe.

Default is just one problem. Company deposits have many other drawbacks.In case you missed, do read my blog post Company Fixed Deposits are toxic investments, avoid. It explains why Company Debt is not the right product for retail investors... and the alternatives.

IMPORTANT: Besides, over the last two decades, this is one of the rarest of rare cases. So, the probability of losing money in debt funds (especially over long term) is practically nil. Debt mutual funds are as safe as, if not safer, than the fixed deposits. And, as they are more tax efficient, they make a great investment for those in the 20-30% tax brackets. In fact, even the 10% tax bracket investors could be better off with debt mutual funds than the bank FDs, when the time horizon is 3-5 years.

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