Author: Mansi Kariya

How PRC Rating Matters in Liquid Funds

On December 2, 2025

Have you thought about the PRC rating in liquid funds? Do you know why it matters and what the matrix represents for these funds?

The PRC (Potential Risk Class) matrix, introduced by SEBI, requires debt funds to disclose the maximum level of risk they intend to take in the future based on their current and future investments.

This matrix evaluates two major risks that debt mutual funds are exposed to:

1. Credit Risk – the risk that the issuer of security may default.

2. Interest Rate Risk – the risk of the security’s value fluctuating due to changes in interest rates.

The position of the debt scheme in the matrix shall be displayed by the AMCs by this matrix. Here is have a look at the matrix –

Let me interpret it for you, the Rows I,II and III represent the interest rate risk a fund can take with Row I being the relatively low risk (Macaulay Duration ≤ 1 year), Row II being the moderate risk (Row II: Moderate risk (Macaulay Duration ≤ 3 years) and Row III being the relatively high interest rate risk (Any Macaulay Duration). In the case of liquid funds, investments are restricted to securities with maturity up to 91 days. Because of this short duration, interest rate risk is minimal. Therefore, liquid funds are always placed in the Row “I” category, indicating relatively low-interest rate risk.

However, the PRC rating still matters because liquid funds can differ in credit risk, depending on the type of short-term instruments they choose—ranging from very high-quality (AAA rated) securities to slightly lower-rated ones. Category ranges from columns A to C represents the credit risk a fund is willing to take, Column A being the lowest and Column C being the highest.

SEBI has assigned a Credit Risk Value (CRV) to different categories of debt securities. The higher the CRV, the lower the potential credit risk—and vice versa.

· Government securities (G-Secs), State development loans/Treasury Bills/ Repo on Government Securities/TREPS / Cash carry a CRV of 13

· AAA-rated securities have a CRV of 12

· AA+ securities have a CRV of 11

· AA securities have a CRV of 10 and so on

Classification based on the weighted average CRV of a fund’s portfolio:

· CRV ≥ 12 → Classified as “A” class (relatively low credit risk)

· CRV of 10–11 → Classified as “B” class (moderate credit risk)

· CRV < 10 → Classified as “C” class (relatively high credit risk)

Although moderate credit-risk funds should theoretically outperform low credit-risk funds on a risk-adjusted basis, the performance differential has meaningfully narrowed over the past one year. This trend has been influenced by improved market flows, compression in credit spreads, and a strategic tilt among fund managers toward lower credit-risk instruments.

^{Median Rolling returns of PRC A-I vs B-I Liquid Funds}

Source: ICRAMFI360, PPFAS Research

The spread between median rolling returns of A-I and B-I rated liquid funds has been reduced over the past year with better liquidity conditions since April 2025. A fund that takes higher credit risk may offer slightly higher returns but with increased potential volatility or credit events. Since liquid funds are designed primarily for short-term goals and emergency requirements, safety and liquidity should be preferred over returns.

Disclaimer – The views are personal. Macaulay Duration (Duration) measures the price volatility of fixed income securities. It is often used in the comparison of interest rate risk between securities with different coupons and different maturities. It is defined as the weighted average time to cash flows of a bond where the weights are nothing, but the present value of the cash flows themselves. It is expressed in years/days. The duration of a fixed income security is always shorter than its term to maturity, except in the case of zero-coupon securities where they are the same. The Potential Risk Class (PRC) matrix, mandated by SEBI, discloses the maximum interest rate and credit risk a debt scheme may assume. PRC classification provides transparency on permissible risk boundaries but does not guarantee safety, liquidity, or returns. Past performance, including the mentioned narrowing of return differentials between A‑I and B‑I liquid funds, is not indicative of future results. Investors should evaluate their objectives and risk tolerance and consult the respective Scheme Information Document (SID), Key Information Memorandum (KIM), and professional advisors before investing.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

Curveball in Credit How Bear steepening is repricing risk and opportunity

By Mansi Kariya

On October 1, 2025

In Uncategorized

Corporate bond yields attracted strong investor interest up to July 2025, with record-high issuances being comfortably absorbed by the market. Spreads remained attractive relative to State Development Loans (SDLs). Backed by the RBI’s liquidity easing measures and a cumulative 100 bps of rate cuts in CY2025, overall liquidity conditions have turned comfortable. Corporate bonds continued to offer appealing spreads as investors sought to lock in higher yields amid expectations of further rate declines. Notably, the corporate bond curve, which had remained inverted last year amid liquidity deficit conditions, has now steepened in line with improving market dynamics.

Bond Yield Curve (31^st July,2025) Source: CCIL (Yields are annualized)

Following the August 2025 monetary policy meeting, a more cautious tone has emerged. Fiscal concerns linked to GST reforms, tariff-related announcements, and subdued bank demand have driven yields higher across G-Secs and SDLs. Elevated state borrowing has also added pressure, with issuances in FY25 (up to 15 August 2025) rising to Rs 3.80 lakh crore compared to Rs 2.53 lakh crore in the same period of FY24. As a result, SDL spreads over G-Secs have widened sharply to 70–80 bps, well above their usual 45–50 bps range. Lower participation from insurance and pension funds—particularly at the longer end, where they typically dominate—has further contributed to the steepening.

In contrast, corporate bond issuances remained muted in August 2025 as issuers refrained from locking in debt at elevated interest rates. A few attempted issues were eventually withdrawn amid higher investor bid expectations. The combination of elevated SDL yields and subdued corporate supply has driven a sharp compression in AAA PSU corporate bond spreads over the past month. While the PSU corporate bond yield curve remains steep, spreads have narrowed considerably—turning unattractive beyond the 2–3-year segment, where they have even slipped into negative territory. The government bond yield curve including SDLs has now turned more attractive, with unusual spreads emerging from the recent steepening. However, given these unusual circumstances, the expectation is that the RBI to intervene and stabilize the market through appropriate measures.

Yield Curve (26^th August ,2025) Source: CCIL (Yields are annualized)

Identification of funds for a short-term goal

By Mansi Kariya

On April 24, 2025

In Behavioral Finance, Investing, Mutual Funds

“Arbitrage” is when one simultaneously purchases and sells the same security in different markets to profit from unequal prices. Arbitrage Funds are schemes that invest a minimum of 65% of money in equity stocks and hedge them with corresponding sale of a futures contract, thereby earning a risk-free arbitrage yield when the positions are held till maturity. However, at every given point of time, the spread between the security so purchased and the future contract so sold keeps changing resulting in volatility on returns at that point of time. Yes, the balance of up to 35% can be invested in Debt securities & Money Market Instruments, however the same differs from scheme to scheme.

As against arbitrage, “Liquid” represents being flexible. Liquid Fund schemes primarily invest in money market securities such as treasury bills, commercial papers, certificates of deposits, etc. having a maturity of not more than 91 days.

Post removal of indexation benefit of Debt Mutual Funds, Arbitrage funds have received significant inflows from investors. Gains from Liquid Funds are taxed at Slab rate while Arbitrage Funds qualify for taxation similar to equity-oriented funds (20% short term capital gains tax if redeemed before one year and 12.5% if redeemed after one year)

Source: AMF

Arbitrage returns can be volatile in the short run (less than 3 months):

Arbitrage yields are more volatile because they are dependent on dynamic factors like market liquidity, transaction costs, price corrections, broader economic and regulatory changes, etc. and all of which can fluctuate quickly. Liquid funds, which invest in short-term debt instruments are less volatile.

The 1 month and 3 month rolling return of both the fund in the below chart shows the volatility of arbitrage fund returns which evens out in the medium term

Source: ICRA MFI Explorer (Annualized average Rolling returns of 5 schemes for 3 month and 1 month rolling one month basis)

The average rolling returns of both arbitrage and liquid Funds over the three-month period are almost similar, making the arbitrage fund more tax efficient over liquid funds. However, one month rolling returns has volatility which investors with short-term goals should be mindful of.

Exit load: Arbitrage funds have higher exit loads if redeemed quickly and are suitable for investments with a time horizon of more than 3 months. In contrast, liquid funds are designed for safer, short-term parking of funds, with lower exit loads if redeemed within a brief period, usually 7 days.

Expense Ratio: Arbitrage funds have higher expense ratios due to the complexity of their strategies, their intensive risk management and the infrastructure required to execute trades efficiently. Liquid funds, by contrast, have relatively less operational demand, leading to lower costs.

Arbitrage funds may be more suitable for investors in higher tax brackets with an investment horizon of at least 3 months and who do not mind some volatility in returns.

On the other hand liquid funds are more suitable for investors with shorter investment horizons or those in lower tax brackets due to their lower expenses, stability and liquidity. Ultimately, the choice depends on an investor’s financial goals, risk appetite, and investment horizon.

Disclaimer: Views are personal

Statutory Disclaimer:
https://amc.ppfas.com/schemes/riskometer-with-media-disclaimers/

Dilemma in selecting hybrid funds

By Mansi Kariya

On January 17, 2025

In Investing, Mutual Funds

Since March 2023, the category of hybrid funds has witnessed a significant surge in assets under management (AUM), almost doubling. This is largely due to the favorable tax treatment of certain hybrid fund types and their ability to offer diversified exposure across different asset classes.

Source: Hybrid Fund AUM (Rs Lakh crore)(AMFI Data)

The rise in popularity of Dynamic Asset Allocation funds, Balanced Advantage Funds , Multi-Asset Allocation Funds, and Equity Savings Funds can also be seen as part of a broader trend where investors are increasingly seeking tax-efficient, diversified investment strategies, especially in the current volatile market environment.

However, investors often make mistakes when selecting these hybrid funds, primarily due to a lack of alignment with their individual risk profiles, financial goals, and other critical factors. Here’s a closer look at some of the common mistakes investors make when choosing hybrid funds and how they can avoid them:

Overestimating Stability and Underestimating Volatility :

Some investors mistakenly believe that hybrid funds, due to their diversified nature, are always low-risk. While hybrid funds are less volatile than pure equity funds, they can still experience significant fluctuations.

A Balanced Advantage Fund /Dynamic Asset Allocation Funds might have a large allocation to equities, which could lead to substantial volatility in bear markets. If an investor expects consistent returns, they could be caught off guard during periods of market downturns.

It’s important for investors to understand that while hybrid funds are designed to reduce volatility compared to pure equity funds, they are not completely risk-free. They can still be impacted by market corrections, interest rate changes, and other macroeconomic factors

Ignoring Fund Strategy and Asset Allocation:

Focusing too much on past returns without understanding the underlying asset allocation strategy of the hybrid fund can lead to poor decision-making. The asset mix and how actively the fund manager adjusts the allocation based on market conditions are crucial factors in determining the future performance of a fund.

Always check the fund’s investment philosophy and asset allocation strategy. This gives a clearer picture of what to expect from the fund beyond just past performance.

Time Horizon:

Hybrid funds, which invest in both equity and debt instruments, typically experience higher volatility than debt-only funds. As a result, these funds are better suited for medium to long-term investment horizons. While they aim to balance risk and return by adjusting the equity and debt allocation, hybrid funds are not immune to short-term market volatility.

For investors with a shorter investment horizon, liquid funds or arbitrage funds are more appropriate.

Comparing one fund with another:

One of the unique characteristics of hybrid funds is their flexibility to allocate between equity and debt based on the fund manager’s strategy and prevailing market conditions subject to SEBI MF Regulations. This flexibility means that hybrid funds are not directly comparable to each other in the traditional sense, especially when compared to more straightforward equity or debt funds.

A Dynamic Asset Allocation Fund may hold a higher percentage in equities during a bull market, while another may hold a lower percentage. Some hybrid funds have a higher equity exposure, targeting more aggressive growth over the long term. Others may maintain a lower equity allocation and balance with arbitrage opportunities, focusing on capital preservation with some growth potential.

The type of debt instruments used in a hybrid fund (e.g., government bonds, corporate bonds, or money market instruments) also affects its risk and return profile. A fund investing in higher-rated bonds will typically have lower risk and lower returns, while one investing in lower-rated bonds could have higher returns, but with a corresponding increase in risk.

Because of the flexibility in asset allocation and different investment strategies, hybrid funds are not easily comparable. When evaluating these funds, it’s important to focus on the investment objective, risk tolerance, time horizon, and management style rather than just comparing them based on past returns or a single performance metric. Each hybrid fund is designed to meet specific investor needs, and understanding the underlying strategy is key to making an informed decision.

Disclaimer: Views expressed herein are personal in nature and cannot be construed to be a decision to invest