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Published on 30/04/2019 12:12:56 PM | Source: HT Media

Opinion | Debt mutual funds: Quantum of loss and solace

Posted in Mutual Fund Analysis| #Mutual Fund #DEBT

 

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The dust had barely settled on the aftermath of the IL&FS default when another issue cropped up. That is, FMPs with exposure to Essel group maturing before 30 September, the date on which purportedly the Zee group promoter will pay up his dues. The standstill agreement ends on 30 September, post which the mutual funds and other holders of pledged shares of Essel group may come to the market to sell to realize dues, if the Zee horror show continues.

Amidst all the grime, the big question in the minds of investors is about the safety of debt mutual funds. Let’s try to form an objective perspective on the issue. As an illustration of objectivity, the amount of money owed to banks by the poster-boys of default, Vijay Mallya and Nirav Modi, pales in comparison to the amount owed by some of the big industrial houses. The big cases are now being dealt with under the Insolvency and Bankruptcy Code (IBC), but does not occupy as much of public mind-space and mainstream media coverage.

To quantify the loss in debt mutual funds, it is not possible to make it completely objective, but we will make an attempt. In IL&FS, when the default happened, the quantum of exposure of the mutual fund industry to the once-perceived-as-bluechip group was being discussed as ₹2,500 crore. Subsequently, in the RBI Financial Stability Report of 31 December 2018, the quantum was mentioned as ₹6,500 crore. MFs have passed on the loss to investors, being a pass-through vehicle. The entire amount may not be a loss, as chances of recovery are there. As per a declaration by the IL&FS new management on 3 April 2019, ₹61,375 crore (69%) is classified as red, ₹16,372 crore (18%) as amber and ₹10,472 crore (12%) is green. Amber companies can pay only operational creditors and red companies cannot pay even operational creditors. Assigning a ballpark recovery probability of 100% to green, 90% to amber and 15% to red, the approx recovery amount is ₹2,500 crore, i.e., the loss is ₹4,000 crore.


Then comes the Essel group issue. The exposure of the MF industry is approx ₹7,500 crore. It is too early to call the amount of loss; the promoter has stated that he will meet the obligations by 30 September by a stake sale. The MFs on their part, hold security cover of more than one time, but what would happen to the share price if all the pledged-shareholders came to sell simultaneously is a big question. In case the promoter defaults on 30 September, it remains to be seen whether the stake-holders grant another extension or sell the shares at whatever value realisable. Apart from the IL&FS Group and Zee Group issues, there were a few other cases that happened earlier with the MF industry. These include Amtek Auto (85% was recovered), JSPL (now back to investment grade), etc. The net loss from these cases is on the lower side, and may be termed as negligible. Hence at this point of time, the MF industry is staring at a loss of approx ₹4,000 crore ironically from an erstwhile AAA rated entity, plus the Zee issue.


To quantify this loss, the perspective is the AUM of the MF industry. The total AUM is ₹23.8 lakh crore as on 31 March 2019, of which the debt AUM is ₹12.2 lakh crore. As a percentage, ₹4,000 crore works out to 0.33%. The latest bouncer to hit us is Reliance ADAG entities, Reliance Home Finance and Reliance Commercial Finance being downgraded to below investment grade, where the exposure of the MF industry is approx ₹2,500 crore. As a ballpark, 0.4% of debt AUM turning out bad, after so many years of existence, is not as bad. For a perspective, the gross NPA of the banking industry, as per RBI’s Financial Stability Report of December 2018, was 10.8% as on September 2018. This is not to say MF debt funds are safer than bank deposits; MF is a pass-through vehicle. Anything going wrong, for instance, IL&FS, will be passed on to investors, whereas bank deposits place the risk on the bank. Unless something goes wrong, you will get your contracted returns, irrespective of the bank’s NPA level.

There may be some shift from debt mutual funds to bank deposits, driven by the headlines, but things are not as bad. There is no guarantee that an event like IL&FS will not recur but, from the credit risk point of view, you may want to invest in better credit quality portfolios like Corporate Bond Fund or Banking PSU Fund. Open-ended funds have relatively less credit risk than close-ended funds like FMPs, as all the securities mature at the same time. The tax efficiency over a three-year holding period is the same in open-ended debt funds, as in close-ended ones.