As NAV math changes, raters seek volatility gauge

With volatility in debt funds set to increase on account of a change in their valuation methodology with effect from today, rating agencies and institutions are hard at work trying to figure out the appropriate rating mechanism for these funds.

Debt mutual funds collect money from investors and invest the proceeds in bonds and other securities.

Hitherto, these funds were rated on the basis of their credit quality, or the quality of the securities they held.

However, now they may also have to be rated to account for the daily fluctuation in the market prices of their securities.

As per an order of the Securities and Exchange Board of India (Sebi) issued in February this year, money market and debt securities with residual maturity over 91 days (or with maturity up to 182-days) have to be valued on a mark-to-market basis. The order takes effect today.

This change is likely to increase the volatility of investments in these funds, something the rating agencies are trying to accommodate in their models, although there is no regulatory mandate to this effect yet.

The changed norm also introduces the possibility that some funds could show negative returns.

According to an industry source, a number of mutual funds which outperform have a markedly different maturity and liquidity profile when compared to their peers. While this increases the risk of negative returns when following a mark to market system, it would not be reflected in the credit rating.

In effect, there would be no easy way to distinguish a fund which has been given the highest credit rating but is more volatile than another with the same credit rating but with lesser risk of

seeing negative returns. And without such a rating, the net

asset value of debt funds may be set for a rocky ride, with unwary investors running the risk of getting hurt.

Going by experts, it is this possibility of a ‘safe’ investment —- as debt investments are generally deemed to be —- showing negative return that has investors looking for a means of rating not just the soundness of the papers the fund holds but also the downside risk that it may carry.

“There has been some interest in the market recently with investors as well as funds asking about rating on the basis of volatility in addition to credit quality of paper,” said Deep N Mukherjee, director, Fitch Ratings.

Since Sebi announced its decision in February, eight out of the top ten fund houses have approached the agency for a volatility based rating, said Mukherjee.

Others may consider following suit sooner than later. “There have been some discussions on the introduction of a volatility aspect to ratings, but something concrete is yet to emerge,” said D R Dogra, managing director at Care Ratings.

“Internationally, the volatility rating is used widely. Going forward, one may want to look at the possibility of its introduction in India,” said Karthik Srinivasan, co-head of financial sector ratings at ICRA.

Currently, debt funds account for two-thirds of the Rs 6.3 lakh crore worth of assets under management of mutual funds.

Source: http://www.dnaindia.com/money/report_as-nav-math-changes-raters-seek-volatility-gauge_1417588