Fixed maturity plans are far from being out of the woods yet.
Last week, Kotak Mahindra Asset Management Co wrote to the investors of Kotak FMP Series 127 saying it will not be able to pay the entire redemption amount. The scheme, a 3-year fixed maturity plan (FMP), was to mature on April 8.
This happened because of Kotak’s exposure to debt-laden Essel Group, the promoter of Zee group of companies.
There are 94 FMPs that have invested in Essel Group companies, according to Morningstar data.
HDFC Asset Management Co Ltd, which had Rs 902-crore investment in the Essel group companies’ debt securities across all its FMPs, had to roll over/extend the maturity of HDFC FMP 1168D Feb 2016 (1) a plan under HDFC Fixed Maturity Plans Series 35, scheduled for maturity on April 15, 2019. The rolled over scheme will now mature on April 29, 2020, if a majority of its investors agree to roll over.
FMP investments have caused stress to its investors even in the past. Let’s look at some history.
Historically, treasury departments of corporates were primarily attracted towards FMPs to deploy their surplus temporary cash.
This set mutual funds in a competition to give higher FMP returns compared to bank FDs and also from competitor MFs. As HNIs and alert retail investors joined FMP investments, the return generating competition heated up.
During 1990s, when cooperates put temporary cash in bank FDs, interest rate was fixed. So when MFs came to the party, they started giving indicative returns and MFs tried to outrun each other to generate these indicative returns, to outperform bank FDs and each other .
SEBI stepped in and halted the indicative return practice as it was a shadow selling of returns guarantee - goes against the mandate that MF investments are subject to market risk.
There was high interest rate returns era on corporate bonds that started from 2007 and went on for a long time including new areas of companies like infrastructure bonds, NBFC bonds.
FDs vs FMPs
Bank FDs could not match this level of returns, so they fell out of favour and FMPs took over big time.
But a thorough reading shows that's where competition heated up as now it became more about which mutual fund house can give higher returns.
To outdo each other, MFs tried another trick.They went to the extent of keeping securities in FMP schemes beyond maturity duration. On maturity they transferred these unmatured securities of matured FMP into another FMP scheme.
SEBI once again stepped in to safeguard investor interest, and said an FMP will invest in securities maturing in line with the maturity of FMP schemes. So a fair equal play between MFs was restored. The market regulator also made credit rated papers mandatory.
Today, the credit rating risk is what MFs take up mainly in FMPs.
This raises important questions - whether credit risk taken by MFs in FMPs is adequately communicated to corporate, HNI and retail investors?; whether the level of credit risk taken is desirable or MFs have gone too far by investing heavily in downgraded sectors like infrastructure /NBFC and highly leveraged company debt papers?; and finally, are investors taken on board with such level of high risk in FMP?
In the wake of the recent fiasco, if mutual funds fail to address these concerns, corporates might have to shift to good old world of bank fixed deposits.