In recent announcement, ICRA placed the rating of six mutual fund schemes under watch. Mutual fund schemes across three fund houses—HDFC, UTI and Aditya Birla—have announced a reduction in the valuation of their investments (haircut), which has led to a fall in the net asset values.
The reason for this is the rating downgrade announced by CRISIL. The downgrade is caused by non-payment of interest and principal obligations by Jharkhand Road Projects Implementation Company (JRPICL), which is a subsidiary of IL&FS Transportation Networks (ITNL), and a part of the Infrastructure Leasing and Financial Services (IL&FS) Group.
To understand it better, let’s quickly see the background situation. Four months back IL&FS defaulted on its loan repayable. This being a rare situation, the government intervened. The National Company Law Appellate Tribunal came into action and stay order was issued to withhold regular debt repayments.
This has triggered a never-before situation for all stakeholders. CRISIL in its note downgrading rating of JRPICL to 'Default' grade (D) mentions, “Invocation of NCLAT's stay order by JRPICL to withhold regular debt payment is not only a reversal of the management's previous stance but also challenges the legal standing of the ring-fenced nature and bankruptcy-remoteness of the SPV. Because of this, despite having adequate cash surplus, JRPICL has defaulted on its debt obligation.”
In the earlier incidence of default, there was a situation of no funds to pay for the interest on and repayment of debt raised. However, this incidence involves the non-payment of dues despite the SPV has enough cash on the books, as per observation by CRISIL. More about this can be read here.
Most investment experts look at this development with caution. “Special purpose vehicles (SPV) are created with an intention that their fortunes should not get impacted if the parent entity suffers in the course of business. The investors are paid out of the cashflows the SPV generate and the ring-fenced structure protects the rights of investors. However, in this case, a moratorium is granted to parent even on the payouts by SPV which will shake investors’ confidence in such ring-fenced structure,” says Ashish Shanker, head – investment advisory, Motilal Oswal Private Wealth Management.
This development has legal consequences and in a way defeats the concept of corporate veil, wherein each company is separate from its promoter for the purpose of law and separates the fortunes of the promoter and the fortunes of the company. Experts pointed out that one should get some clarity on January 28 when the next hearing of this case commences.
Till one gets the clarity, this development may reduce the investor’s appetite for investments in SPV arrangements to fund long gestation projects in infrastructure and real estate where business risks are high compared to other sectors.
The investors will take some time to respond to this development. But the mutual funds have to act on this development. Schemes floated by Aditya Birla Sun Life AMC which had investments in JRPICL has marked down its investments by 20 percent. HDFC AMC and UTI AMC also opted for 25 percent haircut in their investments in similar SPVs though these SPV have not yet defaulted. The net asset values of these schemes have fallen accordingly.
“Though there is no default on the investments held, haircut by HDFC and UTI is an action in the interest of small investors. Had they not taken a haircut, savvy investors could have sold their investments in anticipation of a downgrade,” says Roopali Prabhu, head of investment products, Sanctum Wealth Management.
Though the mutual funds have acted the way they should, there are many unanswered questions in front of investors. First, should they avoid schemes with investments in structured debt or schemes that invest in structured debt?
Though one would want to avoid structured debt for time being, in the real world it may be difficult. Open-ended bond funds have invested around Rs 78,000 crore in such structured obligations (bond instruments), as per Sanctum Wealth Management.
But going forward, investors will definitely turn cautious on these investments. “Not much money is being raised by such SPV now. But because of the IL&FS SPV development, the ability of the SPVs to raise capital will be adversely impacted. Investors may not invest in these SPV till clarity emerges,” says Alok Singh, Chief Investment Officer, BOI-AXA AMC.
The second question investors face, what should they do with their investments in schemes where the AMC has announced a haircut?
Experts say that investors should hold on to their investments. “It is not a credit underwriting skill issue. This is a legal issue and could not have been anticipated at the time of making these investments. The haircut is already in NAV. Hence investors shouldn’t exit in panic since there are cost considerations in the form of taxes payable and exit loads if any,” says Roopali Prabhu.
The third question investors are battling with is where and how should they invest their money going ahead, especially the corpus that is meant for bond funds?
Feroze Azeez, deputy CEO, Anand Rathi Private Wealth Management, said “If you are investing in a bond fund, do check how many securities are there in the portfolio. If the portfolio holds 90 to 100 securities, diversification helps as not all papers default simultaneously.” If you invest in a concentrated portfolio then even one default can cost you a year’s return.
This is the time most investors will be confused about their investments in debt funds. On the one hand, the accrual-based strategies are susceptible to credit events as has been seen increasingly in the last few years. And, on the other hand, interest rate movement in future is uncertain.
Already benchmark bond yield (10-year government security) moved down from 8.2 percent to 7.3 percent between September 11, 2018 and December 19, 2018.
“Interest rates have already moved and there is limited scope for further fall in interest rates. One will only pocket the accrual in long term bond funds after expenses. That makes liquid, ultrashort and other low duration bond funds good investment option for time being,” says Alok Singh.
If you are worried about the credit quality, you may choose to stick to high quality bond portfolios, experts advise. “Credit risk funds are not bad if investors understand the risk involved. If you are keen to contain credit risk stick to banking and PSU bond funds,” says Ashish Shanker. Short-term bond funds that have a track record of sticking to high quality bonds are another option.
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