Why we downgraded these HDFC funds

By Morningstar Analysts |  10-08-18 | 
 

While HDFC Mutual Fund has been in the news recently for going public, it has also been pilloried for its private placement of shares to select distributors ahead of its Initial Public Offering (IPO).

Here’s how the situation panned out.

In the AMC’s draft red herring prospectus, a provision was made for a special quota for its distributors, subject to regulatory approvals. The market regulator, the Securities and Exchange Board of India (SEBI), refused to give it the green signal; as such an arrangement of permitting a special quota for distributors could set a wrong precedent.

Undeterred, the fund house audaciously went ahead with a pre-IPO private placement to a few select distributors (a private placement can be done up to a maximum of 200 persons). This did not go down well with the regulator and was viewed as an act of defiance.

HDFC Asset Management was directed to re-allot the shares allotted to distributors and advisers, ahead of its IPO and return the money it had collected from them, along with interest at the rate of 12% per annum.

The regulator staunchly believed that such arrangements could compromise distributors' ability to give unbiased advice to their clients due to a potential of conflict of interest.

Our View

The provision for a special quota for distributors during the IPO was subject to regulatory approvals. Also, it would be offered to all empaneled distributors at the IPO price and shares would be allotted on a pro-rata basis application amount.

We have no problem with the above.

What we did find disturbing was that the AMC was rather disdainful of the regulator’s reservations by coming out with a pre-IPO private placement at a discount, that too for select distributors.

The IPO was expected to be fairly sought after and one would expect it to have been oversubscribed multiple times. Private placement of shares ensured preferential allotment of shares in a highly coveted offering. Knowing that this would obviously raise a potential conflict of interest with distributors, the AMC should have refrained from such a move.

As per the final offer document, KKR India Financial Services bought out these shares from the distributors/IFAs but we notice that there are still 1.72 lakh shares that are not bought out.

We have always regarded HDFC Mutual Fund as one of the better managed asset managers in India and have rated them as an above-average ‘parent’. This maneuver of theirs is contradictory to what we have come to expect from this asset management firm.

In the light of these events, we have downgraded HDFC AMCs Parent Pillar rating from Above Average to Average.

The following funds shall be downgraded:

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Dhawal Parikh
Aug 12 2018 02:00 PM
I have invested in HDFC Midcap and HDFC Prudence. From the note it is not clear how I have suffered. Noted your point on "potential conflict of interest". Do explain if and how I have suffered in my above mentioned investments.
Sujeet Singh
Aug 11 2018 11:13 PM
I appreciate this move from MorningStar. Just wondering why you left out HDFC Equity? That fund is not doing well since long time and after this misadventure from their end all of their funds should be immediately downgraded.
sreedhar reddy indla
Aug 10 2018 11:23 PM
I didn't expect HDFC AMC's offering of pre-IPO private placement at a discount to selected distributors. i have high regard for the AMC as fairly running entity with good standards and ethics. Slowly, it's losing it's glory. Kudos to Morningstar team for bringing out this news to investor community.
GUNESH APTE
Aug 10 2018 01:50 PM
We expect HDFC AMC Management to be of high quality and integrity.
Some of these moves would not help to maintain high standards which they have been known for across multiple decades.
It is good to see that, Morning Star has taken a note of this and downgraded some of their funds.
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