Explained: Debt funds are supposed to be ‘safe’. So, why is there concern now?https://indianexpress.com/article/explained/explained-debt-funds-are-supposed-to-be-safe-so-why-is-there-concern-now-5671137/

Explained: Debt funds are supposed to be ‘safe’. So, why is there concern now?

While banks are already facing a crisis of NPAs on account of default by a number of corporate entities including large companies, the news of mutual funds having exposure to such companies has alarmed investors in mutual funds.

Explained: Debt funds are supposed to be 'safe'. So, why is there concern now?
FMPs are fixed tenure mutual fund schemes that invest in debt instruments including government securities, commercial papers, non-convertible debentures and certificate of deposits among others, and thus generate interest income for their investors.

While debt mutual funds are considered relatively safe investment instruments, the news of Kotak Mutual Fund writing a letter to investors and acknowledging that it has invested almost 27 per cent of the investment corpus of its Fixed Maturity Plan Series 183 in three troubled entities facing severe liquidity crises — IL&FS Transportation Networks Limited, Edisons Utility Works, and Konti Infrapower & Multiventures — has sent shockwaves through investors. Facing similar pressure on account of exposure to Essel Group companies, HDFC MF has decided to extend the date of maturity of one of its FMPs from April 15, 2019 to April 29, 2020.

What are FMPs and what is the issue that fund houses are facing?

FMPs are fixed tenure mutual fund schemes that invest in debt instruments including government securities, commercial papers, non-convertible debentures and certificate of deposits among others, and thus generate interest income for their investors. They are close-ended funds that mature after completion of a pre-determined time period.

In the case in question, investors who had invested their money in Kotak MF’s FMP in November-December 2015 were ideally supposed to get their capital along with interest income on the date of maturity, April 10, 2019. However, since the fund house had high exposure (almost 27% of initial corpus) to ITNL and two Essel Group companies that are facing a liquidity crisis, the fund house is not in a position to fully honour its commitment. The fund house said that it had repaid 99.25 per cent of the investors’ initial investment, and that it was working towards optimal recovery from two Essel Group companies by September 30, 2019.

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Other mutual funds with exposure to Essel Group companies and the IL&FS Group are also set to face similar pressure when their FMP or debt scheme needs to repay investors on maturity.

Is there a bigger worry?

While banks are already facing a crisis of NPAs on account of default by a number of corporate entities including large companies, the news of mutual funds having exposure to such companies has alarmed investors in mutual funds. If a corporate entity defaults on their payment to the investee schemes, it in turn takes away the ability of the fund house to honour repayment to investors, thereby putting both the interest income and capital investment at risk. It is learnt that mutual funds have exposure of around Rs 3,000 crore to IL&FS Group entities, and of around Rs 7,000 crore to the Essel Group. There may be other such investments that may call for some scrutiny.