‘Mutual Funds’ Flee Government Bonds, After Suffering Severe Haircut

A significant number of collective investment instruments such as mutual funds particularly those managing short and medium-term investments, are distancing themselves from government bonds following substantial losses incurred during the Domestic Debt Restructuring Programme (DDEP). These funds had heavily invested in government bonds, leaving their customers exposed to the risks associated with the government’s debt default and restructuring.

In 2022, the government’s debt reached unsustainable levels, surpassing 100% of its Gross Domestic Product (GDP), leading to a default and triggering the DDEP, which impacted domestic investors, including mutual funds. As a result, these funds suffered a severe haircut, causing a significant loss for their investors.

To mitigate future risks and protect their clients, many mutual fund managers have significantly reduced their exposure to government bonds. Some have ring-fenced investments held before the DDEP, ensuring that new deposits from customers are kept separate and away from government bonds. This strategy aims to shield fresh investments from the haircut and ensure they are not affected by the government’s debt restructuring or the mark-to-market valuationissues.

Fund managers are now focusing on providing stable returns and maintaining liquidity for investors. These funds are shifting their focus to less volatile and more secure asset classes, seeking to offer greater stability as the financial sector grapples with macroeconomic challenges and a limited pool of investment opportunities.

The large-scale exposure of short-term mutual funds to long-term government bonds, which goes against standard investment practice, had previously exposed investors to risks they didn’t anticipate. Customers who believed their investments would be safe from the government debt crisis were caught off guard, leading to a loss of trust and a decline in investment in these collective investment schemes. In response, fund managers have taken steps to insulate clients from further exposure to government bonds, aiming to restore confidence and stabilize their portfolios.