Mutual funds and their debt investments under close scrutiny

Arnav Pandya

There has been a warning given by the Securities and Exchange Board of India to the various mutual funds on the issue of cutting deals with companies that will bail them out. This has the potential to harm the interest of the investors and hence this is something that the market regulator is going to watch very closely. There are various angles that one needs to see with respect to this entire action and understand how the interest of the investors would be compromised. Here is a detailed look at why investors would end up suffering in such a situation.

Debt oriented funds

In debt funds the money of the investor is pooled and then various debt securities are bought by the fund manager depending on the mandate of the fund. There can be funds that have just government securities while others will have other debt investments too. This includes various bonds and debentures that have been issued by different companies. The entire issue pertains to the investment of these funds and this is the reason why the investors have to be alert to the manner in which the funds are maintained. Already there has been a poor experience of the investors with some of their money getting stuck when mutual funds ended up with investments that were downgraded and in one case the company was also not able to repay the fund on time. The investor normally associates debt funds with stability and hence any problem on this front would be a big thing that the investor needs to keep an eye on.

Sweet deals

The nature of the sweet deals that are being referred to is between the promoters of various companies and the mutual funds. There are several companies that are in need of funds and they are unable to raise the required amounts from banks and other sources. In such a position they would go to the mutual fund and issue them additional debt securities which would give them the necessary funds and the fund would be able to deploy the funds that it has in an effective manner. This would be similar to a bail out of the company by the mutual funds by providing them with the necessary liquidity when they need it.

Investor interest

In this entire matter there is a big point that is clearly evident and this is that the investor is getting short changed if such sweet deals actually take place. This is happening because it is their money that is being invested in the companies that are actually poor performing ones and which have problems. In the first instance there is a problem for the companies to pay back their existing borrowings and in such a position if the mutual fund lends more money to these companies then it would put the additional amount too at risk. This risk is actually being borne by the investors and hence this is something that is not appropriate.

In many cases the situation could actually be compounded because it could be that the mutual fund has already invested some money into a few companies which are not doing well. Here the initial amount is already at risk and in order to make this look good if more money is invested then it could end up with a case of throwing good money after bad. In all of the cases the investor is bearing the brunt of the impact and this is something that the market regulator wants to avoid. On their part the investors should also carefully look at the portfolio of their funds and the changes that are being made here because this will give an idea of where their money is going.