Debt funds have a strategic place in a portfolio and offer a distinct advantage and appeal, but investors were apparently not too tuned in to their idiosyncratic risks. It appears that that mindset has changed as they debate the “debt funds are safe” rhetoric.
The 2015 Amtek Auto debacle was brushed aside as an aberration of sorts.
In 2018, IL&FS was the burning issue. In June, IL&FS Transportation Networks delayed repayment of Rs 450 crore of inter-corporate deposits from SIDBI. In August, IL&FS Financial Services defaulted on its Commercial Paper (CP) but honoured it a few days later. In September, the defaults begin to gather in momentum.
Around that time, DHFL share price got hit prompting its chairman and managing director to assure investors that the fall showed “complete disregard for company fundamentals”. The bonds of DHFL were recently downgraded and the company is grappling with a liquidity crisis amid allegations of financial irregularities. The Economic Times reported that the promoters of Dewan Housing Finance Corp Ltd (DHFL) have mandated Barclays Group Plc and NM Rothschild to run a formal process to find a buyer.
One of the outcomes of such a scenario is that fund managers are forced to sell to meet redemption pressures. Naturally this will hit funds with smaller corpuses even more. They will have to exit the “good” (since that is liquid and there will be buyers) to pay for the sins of the “bad”. Consequently, the paper in question will corner a greater portion of the corpus as was originally intended.
Exposure to DHFL and associate companies as a percentage of portfolio:
- DHFL Pramerica Ultra Short Term: 33.78%
- Principal Low Duration Fund: 25.49%
- BOI AXA Short-Term Income: 23.86%
- JM Income: 21.79%
- JM Short Term: 21.30%
In the middle of this storm, the Essel Group was shoved into the limelight. Subhash Chandra had pledged a substantial portion of his shares in Essel Group’s Zee Entertainment Enterprises Ltd. and Dish TV India Ltd. against loans. This money was used to fund certain infrastructure projects which turned out to be disastrous investment decisions, as he himself admitted in an open letter.
In November, he announced that he would sell up to 50% of the promoter stake in Zee Entertainment. Soon his publicly traded companies began to see their share price topple.
The terms of the bond stated that if the equity-cover falls below a certain level (due to a fall in the share price), mutual funds could either demand a ‘top up’ of equity or sell the shares they already held. Instead, a standstill arrangement was agreed upon and extended up to September 30, 2019. Do note, the standstill is only on the loan against shares - the principal, interest and the amount that accumulates until the deadline. Also, despite getting some rope, there will be debt paper maturing before this deadline, which means payment obligations will have to be met.
Exposure to Essel Group as a percentage of portfolio:
- Baroda Credit Risk Fund: 17.77%
- Baroda Treasury Advantage: 16.6%
- Baroda Short Term Bond: 15.59%
- Baroda Ultra Short Duration: 6.31%
- ABSL Credit Risk Fund: 5.62%
- ABSL Dynamic Bond Fund: 8.02%
- ABSL Medium Term Plan: 12.54%
The exposure in INR terms of all AMCs to the Essel Group and DHFL can be viewed here.
The rationale that a sudden sale would hammer the price down even more, does give some merit to the standstill arrangement. A default would mean selling the collateral shares. Large-scale share sales would drive prices even lower.
Having said that, in the case of the standstill arrangement, if the borrower fails to meet interest or principal obligations on borrowings against pledged shares till deadline, the paper will get downgraded to default. That would be an extremely unfavourable situation.
Not to be left out, the Anil Ambani-led Reliance Group also arrived at a standstill arrangement till September 30 and stated that it has appointed investment bankers to sell a part of its direct 30% shareholding in Reliance Power Ltd to institutional investors. The standstill relates to the collateral offered for the NCDs issued by privately held Reliance Big Pvt. Ltd. and Reliance Infrastructure Consulting and Engineers Ltd.
The mutual fund exposure to paper from ADAG is:
- Rs 824 crore in short-duration funds
- Rs 586 crore in medium-duration funds
- Rs 125 crore in ultra short-term bond funds
- Rs 254 crore in low-duration funds
- Rs 1,561 crore in credit risk funds
Based on the above, the two AMCs with the largest exposure are Franklin Templeton AMC (Rs 1,125 crores) and Reliance Nippon (Rs 1,459 crores).
All the fund-related data has been taken from Morningstar Direct based on portfolio disclosures of December 2018.
So what must investors do?
KAUSTUBH BELAPURKAR, Morningstar India’s director of fund research, shares his views:
As mentioned above, the standstill agreement holds till September 30, 2019. This gives the firms some rope to hang on to and it is evident that there is a genuine attempt to pay back lenders. Every promoter is not a willful defaulter.
The promoters of Zee Entertainment Enterprises Ltd, the flagship firm of the Essel group, are open to sell over 50% of their holdings in the firm in an attempt to honour its lenders. This week, it was reported that U.S. cable major Comcast and Sony Corp have been shortlisted for talks that could lead to the purchase of a substantial stake in Zee Entertainment.
Anil Ambani’s Reliance Capital offers to sell its 43% stake in mutual fund business to Nippon Life. It has also been reported that the promoters are planning to offload around 19% of their 30% direct holding in Reliance Power. JP Morgan is said to be appointed as the banker for the proposed sale.
DHFL Vyasa and Aadhar had merged to become Aadhar Housing Finance Limited, a firm which provides housing to low income groups. This month, Blackstone acquired the firm as Wadhawan Global Capital, parent of DHFL, sold its 70% holding, and Dewan Housing Finance Corporation sold its 9.2% as part of the same transaction.
Where the debt downgrades of DHFL are concerned, they are either AA+, AA, or AA-. The CP issue is rated A1+, which means that it is placed on credit watch with developing implications. The rating agency in a note explained that stock prices and credit spreads of NBFCs and HFCs have been negatively affected, while recent media news related to DHFL further impacted market sentiment. As a result, DHFL’s ability to raise resources at competitive rates would be crucial for its profitability and long-term growth prospects going forward.
As far as investors go, there seems to be a sudden discussion on whether they should move their money into overnight funds. Be pragmatic, not reactive. Would doing so serve any purpose from an overall portfolio point of view?
Debt funds comes in various hues and all have their specific risks. It is misleading to club them together as one, and worse still to view them as fixed deposit substitutes. Investors must evaluate their ability to handle risk and pick the right fund, depending on the tenure of the investment and their risk profile.
With any market-related instrument, there will be risks. In the above cases, it has been credit risk. If you are genuinely spooked by such incidents, then you should consider safer funds that invest predominantly into the AAA bonds of Banking and PSUs, corporate bond funds, and short-term funds. Even then, check the portfolios as some hold significant amounts of non-AAA rated paper. Also, check if there is undue high exposure to a single issuer – either a company or a group.
We would also suggest that you talk to your financial adviser.
