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IL&FS crisis aftermath: Debt funds rationalise their investments

Different fund houses used to mark down their securities depending on their internal guidelines, however, after IL&FS crisis, things have changed

March 28, 2019 / 10:41 AM IST

Net asset value (NAV) of an equity mutual fund scheme reflects the value of underlying securities an investor holds when he or she invests in it. Similarly, a debt fund’s NAV is also quite realistic to the value of its underlying securities.

So far, the securities that matured in 60 days and less were not marked to market. Further, if the credit rating of debt securities fell below investment grade rating (‘BBB’ rating), then fund houses were asked to value them as per their internal guidelines.

On March 22, the capital market regulator, Securities and Exchange Board of India (SEBI) increased the threshold for fund houses to value their underlying securities more realistically.

It said that all securities that mature in more than 30 days must be marked to market. Further, it rationalised the way debt funds value securities whose credit rating falls below investment grade.

So far, SEBI had given a broad guideline as to by how much and how soon should debt funds write down the value of their securities whose credit rating falls below investment grade.

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As per a circular, it had issued in 2000, it said fund houses should mark the security down by 10 percent after six months past the due date of interest. In comparison, a security is declared non-performing asset (NPA) if interest is not paid for three months.

The guideline further says another 20 percent of the security’s value should be marked down after nine months past the due date. Then, another 20 percent of the security’s value should be marked down after 12 months past the due date. Finally, the remaining 25 percent of the book value of the asset should be written off 15 months past the due date.

The fund houses have been proactive in following the guideline, as much as writing down values of securities that have defaulted even before the mandated time period.

“The idea is why to wait for 15 months if the security has been declared an NPA and when we know for sure that the payment is not going to come”, said the head of compliance of a fund house requesting anonymity.

That’s fine, but here’s the problem. Different fund houses used to mark down their securities depending on their internal guidelines. When debt securities of Infrastructure Leasing & Financial Services (IL&FS) and some of its subsidiaries was downgraded in August-September 2018, different fund houses had marked down the securities by different margins.

For instance, one small state-owned fund house marked down an IL&FS security by around 24 percent. But a large private sector fund house marked down the same security by 48 percent.

Now, SEBI has said that the rating agencies will provide the values of even the downgraded securities to all the fund houses. All fund houses will need to mark down their securities accordingly.

Every day, two rating agencies—Crisil and ICRA—collate the values of all securities (rated above investment grade) that all fund houses have invested in. They send this list to fund houses who then use the data to value their respective securities to ascertain their schemes’ NAVs.

But till date, Crisil and ICRA value only rated securities. Once the ratings of securities fall below investment grade rating, the fund houses’ internal guidelines take over and value such securities, keeping in mind SEBI circular mentioned above.

“Sebi’s original guidelines to value NPAs allowed fund houses time till 18 months past due date to completely mark down their securities. But the recent IL&FS crisis has shown that fund houses have felt the need to mark down their securities swiftly and don’t need to wait for so long. The next step is to modify SEBI circular that it had issued in 2000”, says Joydeep Sen, founder, wiseinvestor.in.



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