Every year, the mutual fund industry (MF) spends crore in advertisement business to make you understand the benefits of diversification, and how your money gets handled by a professional management. Although, it does not guarantee you that all your risk will disappear, or your mutual fund units would never slip below its net asset value (NAV) or for that matter any credit crisis will not take away your hard-earned investment money.
In March, 2019, the share of retail investors in debt and debt-oriented products constituted 37 per cent of the total asset under management (AUM). The percentage is big enough to understand that there is a reason why investors have become more cautious and apprehensive about their investment in debt funds in the recent light of the unfolding of events.
Since the Infrastructure Leasing & Financial Services (IL&FS) crisis in September 2018, which defaulted on its debt obligations as they piled up too much debt by over borrowing through cheap short-term commercial papers (CP) for funding its long-term projects led to asset-liability mismatch. Some debt funds which got impacted largely post crisis, had a contagion impact on few companies in the non-banking finance companies (NBFCs) and housing finance companies (HFCs) space. This led to the overall sentiment turning sour along with the crisis of confidence with the investors.
Although a lot of trouble became unavoidable since April 2019, as many companies have either defaulted across few debt papers or have been downgraded by credit rating agencies (CRAs) which were held by some mutual fund schemes. The companies, which came under the scanner includes Dewan Housing Finance Corp (DHFL), Essel Group companies, Anil Dhirubhai Ambani Group companies (ADAG) and Yes bank (See table: Mutual Fund’s Exposure so far).
The value research data showed, Fixed maturity plans (FMPs) of eight fund houses including HDFC, ICICI Prudential, Reliance, Aditya Birla Sun Life, Kotak, DSP, DHFL Pramerica and UTI had exposure in distressed companies from Essel Group and IL&FS. The development came under the lens of Securities and Exchange Board of India (Sebi) who issued separate show cause notices to HDFC Mutual Fund and Kotak Mutual Fund seeking explanations of the terms of their investments in Essel Group’s debt securities. As for Kotak Mutual Fund, it said to investors that it would not be able to pay the entire amount of their three year FMP schemes, which matured in April-May 2019.
Amongst other investments, Kotak’s scheme also had an exposure in the Non-Convertible Debentures (NCDs), which were issued by Edisons Utility Works and Konti Infrapower & Multiventures (part of Essel group companies) on the back of 1.27 crore Zee Entertainment Enterprises’ equity shares as collateral.
While some fund houses marked down the value of their affected securities, in order to recover value, some fund houses invoked the pledge by selling shares, while others decided to allow part redemption or have either rolled over their maturity date.
Kotak AMC came to an agreement with the promoters that they will not sell their shares till September 30, 2019, as they expect to recover the dues from the group. On June 18, HDFC AMC in its filing with National Stock Exchange (NSE) decided to buy out or take on its own books up to `500 crore worth of Non-Convertible Debentures (NCDs) of the Essel Group as part of the “Liquidity arrangement.” The AMC has offered to provide exit to its FMPs unit holders of HDFC Mutual Fund schemes, that were affected by exposure to the NCDs of Essel group companies Edisions Infrapower & Multiventures and Sprit Infrapower & Multiventures.
Whenever the rating of a paper held by the FMP scheme is downgraded, delayed or defaulted in repayment by the borrower, the investor has to stare at the fall in the NAV of the schemes helplessly.
Deepak Jasani, Head, Retail Research, HDFC Securities, explained, “This situation created an aversion to FMPs in April (which is traditionally a hot month for new issues) and the amounts from earlier issued and now maturing FMPs were not reinvested in other FMPs. Even AAA FMPs had to face issues due to sudden sharp rating downgrade or default or delay in repayment by the borrower.”
However, market experts say, the outflow of Rs17,644 crore in FMPs is because of their maturity, seen in April 2019 as compared to outflow of Rs1797.9 crore seen in May 2019.
Most FMPs are launched in January-March and tend to mature in April-May, the start of the new financial year. This is done so that investors get the indexation benefit for tax purposes. Sandip Raichura Head of retail Prabhudas Lilladher, added, “Thus, the outflows reported by FMPs in the AMFI report is of the schemes that have matured in April, and should not be construed that investors are redeeming their investments.
In April, almost 65 schemes matured with a total corpus of about Rs17,000 crore as on March 31, 2019. Whereas out of the current FMPs, about 57 per cent of the schemes matured in the months of April-May.”
This is not the first time were the debt woes of India Inc’s financial stress has spilled over to the debt mutual funds making them riskier. “In the past we have seen downgrades and defaults by Amtek Auto, Jindal Steel and Power, Ballarpur Industries, etc and more recently we have seen it with IL&FS followed by some Essel group companies and more recently DHFL,” claimed Neil Parag Parikh, Chairman and CEO, PPFAS Mutual Fund.
For investors, it is crucial to understand that downgrades do not equal to default especially when later on, the fund receives payment on the instrument, which will be reversed in the book of loss. As per the current Sebi regulation, in case of a default, a fund house should necessitate a 75 per cent mark-down of valuation for secured papers and 100 per cent with regards to unsecured papers.
Post the case of DHFL, which defaulted by missing its interest and principal repayment on June 4, the fund houses marked down their investments in DHFL by 75 per cent. This event led to erosion of NAV’s of several debt schemes to fall more than three per cent.
So, what led some fund houses to take riskier bet in their debt mutual fund schemes that led to the concentration of risk with regards to their corporate debt paper? One of the answers being that it was purely the play of miss-selling and the allocation mistakes (can be allocators, advisors, direct investors, bank distributions, mutual fund recommendations and IFA) echoes some fund managers. “In our understanding in the last three to four years, we have seen that as the deposit rates were falling, as a result most of the debt MFs were sold as an alternative to generate slightly higher returns than fixed deposits,” said Pankaj Pathak, Fund Manager-Fixed Income, Quantum Mutual Fund. “So major reason being hunt for higher yields was one the major reason which attracted the lot of investors into the debt schemes and even fund managers took more risk to generate that high yield,” he further added.
In a quest to generate slightly higher credit risk, in the last four-five years lots of money flowed in MF Industry especially Debt funds (See the table: Booming growth of Debt funds AUM). Although the volumes kept flowing there was scarcity of liquidity seen in the secondary market.
“Usually during the times of Rating—downgrade or default, affected instruments become illiquid in the secondary market. If investors rush for mass redemption due to panic, fund manager would be forced to sell other good or quality papers to meet the redemption pressure. Then what the portfolio would be left out with is the illiquid or low quality securities. It affects all,” pointed out Sriram BKR, Product Head, Distribution from Geojit Financial Services.
One of the fundamental problems in the fixed income market is the lack of liquidity and the lack of depth in the fixed income market.
G Pradeep Kumar, CEO, Union Mutual Fund, echoed, “Probably there are fund houses, which realised say six months back or nine months back that there is a problem with say a particular company and now they would like to sell the bonds, this is not possible in the fixed income. See, if you have a bond of any corporate bond our current market is just not deep. There has to be liquidity. If that happens then there is more trading in the market and investors can get a fair price.”
Alternatively, experts say, post the mark down of securities, if there are inflows in the concerned scheme than the same is negative for the existing investor as the new investors may also benefit in case of any recovery of marked down securities.
“AMCs often restrict inflows after a security has been marked down to prevent interest of existing investors,” said Devang Kakkad, Head, Research, Equirus Wealth.
The credit risk funds, which invest in minimum investment in corporate bonds 65 per cent of total corpus played a pivotal role to achieve that extra return in the whole credit risk fiasco. “Credit risk funds a typically are considered to be having high credit risk as they invest in lower credit quality papers where the probability of default is generally higher as compared to a sovereign/AAA/AA+ issuer. The current credit crisis underscores the risk being carried by credit funds,” believes Avnish Jain, Head, Fixed Income at Canara Robeco Mutual Fund.
Some experts have pointed out that credit risk should have been the part of the alpha bucket allocation but was wrongly sold in the core bucket. Investor expectations being that was that this is part of my safe allocation. Which is why the impact is so large.
“The problem over the last few years has been that credit risk funds have been bought in the ‘core’ bucket of fixed income allocations. This bucket for investors means the safest play and hence should only have funds which are low on both duration and credit risks. So that is probably an asset allocation mistake that needs to be rectified. Had credit risk been part of investor’s ‘alpha’ bucket their exposure to credit would have been much lower, and the expectation with respect to the product performance may have been different as well,” said Suyash Choudhary, Head, Fixed Income, IDFC AMC.
Currently as per the new classification, regulator has classified debt mutual funds under 16 categories depending upon varied instruments and risk profiles.
In the research report released by JM Financial on India Asset Management, noted the debt mutual funds AUMs declined by 12 per cent as on May-2019 Y-O-Y. The recent credit crisis prompted investors to reduce exposure or exit the affected funds leading to fall in debt AUM.
Highest outflow was seen in credit risk funds since April 2019. Amongst debt mutual fund schemes top AMCs, SBI AMC, ICICI Prudential AMC and HDFC AMC have gained 147 basis points (bps), 62 bps and 25 bps of market share respectively since May-18, whereas UTI AMC and Birla SL AMC have lost 134 bps and 47 bps of market share respectively since May-18. The overall AUM of the Indian MF industry grew by nine per cent to Rs25.93 lakh crore in May 19 over March 2019.
Some of the better managed schemes have not been affected by these credit events as their exposures were lesser to these categories. Hence, it would not be right to say that the category as a whole is in a bad shape said some experts.
Debt funds always had an element of risk and the recent credit events have just exemplified this risk.
Omkeshwar Singh, Head Rank- MF, SAMCO Securities, pointed out, “Investment in mutual funds is subject to market risk, this is not only for equity funds but also for debt funds or any other funds. Majority of debt mutual funds have remained unaffected; the impact is only on those debt mutual funds with certain schemes had exposure to these groups. However, the general investor’s sentiments towards debt mutual funds has temporarily been negative.”
Sebi has taken various active steps in the past such as categorisation of mutual fund schemes and the side pocketing guidelines in protecting the interest of the investors.
Going forward one major event yet to impact mutual funds industry is the full union budget, that would set the new tone for the industry in near term.
Till then, it is just a matter of time before the debt MF industry retrieves its lost glory!
himali@outlookindia.com