Explained: Should debt mutual funds investors worry?https://indianexpress.com/article/explained/simply-put-should-debt-mutual-funds-investors-worry-5675525/

Explained: Should debt mutual funds investors worry?

Two mutual fund houses have acknowledged exposure to securities of troubled group firms. How such schemes work, the risk they sometimes carry, and what has happened to raise investors’ concerns

The headquarters of Infrastructure Leasing and Financial Services Ltd in Mumbai. (Reuters Photo)

Investors in debt mutual funds had a scare last week after Kotak Mutual Fund and HDFC Mutual Fund wrote to their investors acknowledging that they have exposure to securities of troubled Essel Group companies. While Kotak said it has returned nearly 99% capital of its Fixed Maturity Plan (FMP) investors and will return more with accrued interest after a successful strategic sale of Zee in September 2019, HDFC MF said it has extended the date of maturity of one of its FMPs from April 15, 2019 to April 29, 2020.

Generally considered safe for investment with funds parked in government and private-sector debt instruments offering fixed returns, debt-oriented schemes also carry a risk though not as high as equity schemes. For investors in debt schemes, it is important to know that if their debt MF scheme has invested in debt securities of a company that is not financially strong and is facing liquidity pressure, then their investments may suffer in the event of a default by that investee company.

A look at the current case and how it impacts investors:

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

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FMPs are fixed-tenure mutual fund schemes that invest in debt instruments including government securities, commercial papers (CPs), non-convertible debentures (NCDs) and certificates of deposits (CDs) among others and thereby generate interest income for investors. They are close-ended funds that mature after a predetermined time period.

In the case in question, investors who had put 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 it has repaid 99.25% of the investors’ initial investment and that it is working towards optimal recovery from two Essel Group companies by September 30, 2019.

Other mutual funds such as HDFC Mutual Fund and Reliance Mutual Fund with exposure to Essel Group companies and IL&FS Group are also set to face a similar issue when it becomes necessary for their FMP or debt scheme to repay the investors at maturity.

How much investment is stuck in the non-convertible debentures?

The total exposure of mutual funds to Essel Group companies is around Rs 7,300 crore. However, Reliance Mutual Fund, Kotak Mutual Fund and HDFC Mutual Fund have lent around Rs 950 crore to Konti Infra and Edisons Utility by subscribing to the non-convertible debentures issued by the two companies in 2015-16. While Reliance MF had lent around Rs 510 crore to the two companies as of March 2016, Kotak MF had exposure of over Rs 300 crore to the two entities. HDFC Mutual Fund too subscribed to NCDs issued by Edisons and lent around Rs 150 crore as of March 2016.

Is there a bigger worry?

While banks are already facing a big NPA crisis on account of default by a number of corporate entities on their debt instruments, including large companies, the news of mutual funds having exposure to such companies has raised an alarm among investors of mutual funds. If a corporate entity defaults on payment principal and interest to invested MF schemes, it takes away, in turn, the ability of the fund house to honour repayment to its investors. Thus, it puts both the interest income and capital investment of the MF investor at risk. With more and more corporate entities facing debt woes, the banks, NBFCs and mutual funds that have exposure to debt papers of such companies fall at risk.

In India, while government bonds are the safest investment instruments, debt papers issued by blue-chip companies are also considered low-risk investments.

Are retail investors also getting impacted?

While debt-oriented mutual funds are mostly subscribed to by corporate investors and high net-worth individuals (HNIs), or those investing Rs 5 lakh and above, the share of retail investors in such schemes has grown over the last four years. As of December 2018, while the total asset under management of debt-oriented schemes stood at Rs 694,506 crore, the share of retail investor money amounted to Rs 72,214 crore or 10.3% of the total AUM. In December 2014, the share of retail investor money in debt-oriented schemes was 6.8%. On the other hand, the share of corporate investment in debt-oriented schemes currently stands at 51.5% , and HNIs’ share is around 36%.

So, retail investors too have exposure to such schemes and their money is at risk on account of fund houses’ exposure to Essel Group companies.

Looking at equity-oriented schemes, retail investors are the dominant players and their share in the total equity-oriented schemes’ AUM of Rs 8.4 lakh crore is nearly 52%.

Have there been such instances in the past, too?

While the exposure of MFs to Essel Group companies has come as a fresh concern, a series of defaults by the IL&FS Group companies on CPs beginning August 2018 had put them under a lot of pressure then. Many corporates, mutual funds, and insurance companies invested in CPs and NCDs of the IL&FS Group, and following the default their funds have been locked in IL&FS debt instruments, leading to a liquidity crunch. The situation created a liquidity shortage of over Rs 90,000 crore in the system.

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In fact, Kotak Mutual Fund, whose eight FMPs (with investment corpus of over Rs 2,000 crore) have exposure to Essel Group companies, had also invested around Rs 85 crore in IL&FS Transportation Networks Limited. While the fund house hopes to recover its investments in Essel Group entities, it has already written off the investments in ITNL.