Viewpoint | FMP ‘Immaturity’ And Lessons Learnt

The risk level is higher in close-ended funds than in open-ended funds because all the securities mature on the same day.

Lots have been discussed about the lack of full maturity pay-out in FMPs of two large AMCs. One of these had exposure to IL&FS group entities that have been written off i.e. the loss passed on to investors, and both of these had exposure to Essel group entities in the form of Loan against Share (LAS) deals. The backdrop is now well known: IL&FS/group entities, particularly the ones classified in red category, have a slim chance of recovery. Zee group promoter has asked for time till 30 September 2019 and is looking at a stake sale to gather resources and pay off overdue debt. With this background, let us now look at the lessons learnt.

One, the response of AMCs to the issue can be different. One AMC is paying out all the maturity money. But, for the troubled exposure to Essel group entities, it is communicating the justification to investors/distributors. Another AMC has extended the maturity of the FMP by approximately one year. The logic given for the extension is “due to current interest rate scenario and portfolio positioning, the yields prevailing in the short maturity bucket present an option for investors to lock-in their investments at current prevailing yields”. The reason for the extension is obvious i.e. exposure to Essel group. But, the stated reason befits a product maturing more on April 1 than on April 15. The large AMC may look at ‘Zee-less’ maturity for the other FMPs as an option.

Two, mutual fund investments are subject to market risks. This is not just a line read out at a fast or slow pace, but a fact of life. Should it dissuade you from investing? No. A mutual fund is a vehicle to invest in the market and is as safe or as risky as the underlying market. The equity market gives higher return than debt and is more volatile. The debt market gives relatively lower returns and is relatively less volatile. It may seem, after the debt market movement in 2018 and the IL&FS and Zee episodes, that debt is volatile. However, if you look at long period performance, in spite of market movements and defaults/delays, warts and all, debt has been relatively stable.

Three, are fund managers not doing a good job, or are they not doing proper due diligence? They are doing their job. Once in a while, things can go wrong, and everybody is fallible to mistakes. In case of IL&FS, there are many stakeholders, and everybody went wrong in their judgement. The Zee group is going through a horror show. Hopefully, the episode will get over on September 30, 2019. Otherwise, we are in for the next episode. But, exposure to LAS deals is avoidable in FMPs, appropriate for credit risk funds.

Four, are fund managers taking too much risk? Arguably, yes. But, while investing, investors ask about returns, not risks. Only when something goes wrong, people remember something called risk and blame the fund manager for taking a fat salary and not doing a proper job. Had it been the other way round, i.e. risk before returns, we would have seen Government Security-based FMPs, which has not happened yet.

Five, how does it look for the future? People ask, when is the next IL&FS going to happen? Nobody knows. There is no guarantee that such events will not recur. There has been a bunching of events – IL&FS, Essel and, to an extent, DHFL. Decades of track record show that, apart from occasional issues, the credit risk management of the MF industry has been decent. Having said that, mutual fund is not the same as bank deposits as MFs are pass-through vehicles. Any risk, be it market volatility or credit risk, is on the investor, and the MF will pass it on. In bank deposits, it is contractual: the NPA risk is on the Balance Sheet of the bank.

Six, the risk level is higher in close-ended funds i.e. FMPs, than in open-ended funds because all the securities mature on the same day. In open-ended funds, even if there is an issue in one security, the fund goes on. If the objective of investment in an FMP is tax efficiency over a three-year holding period, the same tax efficiency is available in open-ended funds. Go for relatively lower maturity open-ended funds to limit market volatility.

Seven, the standstill agreement between MFs and Zee promoter to not sell the shares is akin to ever-greening, the first such instance, which banks have been doing for ages. It is likely that SEBI will come up with some regulation on this.

It will take some time for the dust to settle down as there are more FMPs with exposure to Essel group LAS deals maturing before September 30. MFs are not disposing of the shares due to the standstill agreement. On your part, keep on doing your portfolio allocation without recency bias.


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