DIE Another Day, Handhold Your Clients Now

Whenever there is an issue in the market, the natural tendency is to escape i.e. redeem from the troubled funds. However, not every exit decision is optimum.

Let’s look at the foremost issues that are currently occupying our mind.

It began with the default of IL&FS group entities in September 2018. Just to put in context, the exposure was not limited to credit-risk-oriented funds but across fund categories. Post-default, AMCs have written off the exposure completely, passing on the loss to investors. As per SEBI rules, AMCs have 18 months to write off but they did it in a short span of time, to clean up the portfolios. Now that the loss has been passed on to investors, any recovery that happens in future will come to the fund, hence it is advisable to stay put. Simply put, if your clients exit, they are giving up their chances of recovery.

After the IL&FS issue, there was the issue of special purpose vehicles (SPVs) of the IL&FS group, which are legally ring-fenced vehicles and not impacted by the profits or losses of the sponsor. The SPVs defaulted, in spite of having money due to a legal interpretation as the sponsor i.e. IL&FS is in NCLT. Recently, the new management of IL&FS has proposed to categorize the various companies of the group in three categories as per repayment ability. The SPVs, having the requisite money, are in green category and are expected to pay up in some time.

DHFL is a curious case as all the noise about them is negative: stock price has been beaten down, bond yields are sky-high and credit rating has been downgraded. However, they have not defaulted and the promoter has committed to honour all obligations. Credit rating, downgraded to AA+ from AAA, is still high investment grade.

In case of Essel group entities, it is debatable whether they have defaulted or not. Zee entities have not defaulted on any bond maturity or interest servicing. The only issue is, in certain Loan Against Securities (LAS) exposures, where the share coverage dipped below the contractual level as stock price crashed, they did not provide the cash top-up. As an illustration, if the share price cover in the LAS deal is to be maintained at 1.7 times of the loan amount and the coverage dips below 1.7 due to fall in share price, the issuer (Zee group entity) is supposed to give additional security within a stipulated time. In the recent stock price stumble, the cover became inadequate and two institutional investors sold shares of Zee entities. Others institutional investors including mutual funds are not selling it as part of an understanding.

Volatility or uncertainty is part and parcel of any investment, including fixed income mutual funds. What is happening currently is, a bunching of negative credit events. One default has happened i.e. IL&FS / group entities. IL&FS SPVs would pay up in sometime. The other two, DHFL and Essel groups are going through troubled times but have not defaulted as such and the promoters have committed to meet their obligations. The other issue going on is about LAS exposure to Reliance ADAG group entities not honouring the top-up requirement on fall in share price. In the mutual fund industry, exposure to ADAG group is lower than that to the others (referred to as DIE above). Over the next few months, if there is no other default or issues of concern, things will stabilize and sentiments will improve.

The bigger issue here is the confidence of your clients on debt mutual fund.

Remember 2013, when RBI had to squeeze liquidity due to high volatility, debt funds gave negative returns but stabilized later. Today’s situation is relatively better; most debt funds are giving positive returns. Only a handful of funds with exposure to IL&FS have given negative returns but with chances of recovery. For investors looking at safe debt funds, the recommended categories are Banking and PSU Funds and Corporate Bond Funds. These funds invest in better credit quality securities and don’t go aggressive on duration.  

For existing investors, who are concerned about their investments in funds with exposure to DIE, the situation is not as bad as to recommend an urgent exit. For IL&FS, stay put; for DHFL, Essel and any other perceived risky exposure, if you have completed three years of holding, you can take advantage of the tax efficiency and redeem. Otherwise, if the fund is not very heavy on the risky exposures, given that the fund has already taken a hit on mark-to-market, hopefully things will stabilize from now on.  

source: https://cafemutual.com/news/guestcolumn/363-die-another-day-handhold-your-clients-now

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