Opinion | The risk in Fixed Maturity Plans is now out in the open

Other fund houses’ FMPs coming up for maturity in the next two months that had invested in Essel group companies, too, are expected to either give the remaining money back to their investors and hope to pay the rest after recovery or roll over the FMPs for another year.

December 2018 portfolios show that fund houses had parked Rs 8,002 crore in debt securities of Essel group companies. Of this, Rs 1,673 crore was held by FMPs (Kotak AMC’s FMPs held around Rs 381 crore) and the rest by open-ended schemes, as per Morningstar India data. A total of six fund houses had FMPs that invested in securities issued by Essel group companies.

HDFC Asset Management Co Ltd, which had Rs 902 crore invested in Essel group companies’ debt securities across all its FMPs, has told Moneycontrol that it has chosen to roll over/extend the maturity of HDFC FMP 1168D Feb 2016 (1) a plan under HDFC Fixed Maturity Plans Series 35, due for maturity on Monday, April 15, 2019. The rolled over scheme will now mature on April 29, 2020, if a majority of its investors agree to roll over.

“The purpose of rollover/ extension is due to current interest rate scenario and portfolio positioning, the yields prevailing in the short maturity bucket present an option for investors to lock-in their investments at current prevailing yields,” its emailed statement said.

Flashback

Since August 2018, debt mutual funds have been found investing in securities that have faced several headwinds. Around August–September 2018, Infrastructure Leasing & Financial Services Ltd (IL&FS) and a few of its subsidiaries’ debt instruments were downgraded on the back of weak financials and default in payment of interest and repayment of principal.

A total of about 33 funds (across liquid, ultra short-term bond funds, short-term bond funds, credit risk funds, etc.) had these companies in their portfolios at that time. The cumulative value of the holdings in these funds added up to Rs 2,308 crore as at end-August 2018, according to data from Crisil.

Soon after, Dewan Housing Finance Corporation’s (DHFL) share price fell. A hike in its borrowing rates following the liquidity crunch after the IL&FS crisis, coupled by allegations of siphoning off funds made by an online investigative portal, spelt bad news for the group and debt funds that had lent to it. DHFL, too, was downgraded.

The Zee problem

On 25 January, shares of Zee Entertainment Enterprises (ZEEL) fell 26 percent and those of Dish TV India fell nearly 33 percent. Here, mutual funds had invested in debt securities issued by some Essel group companies. This particular lending agreement was secured by equity shares of ZEEL and Dish TV so that if the value of shares fall below the agreed limit, lenders such as mutual funds have a right to sell the shares and take their money back or force the borrower to pledge more shares as guarantee.

But when a few lenders went ahead and sold the shares because they must have thought a possible default was imminent, the share prices collapsed. As per the agreement, mutual funds were supposed to either sell the shares or force Essel group promoters to pledge more shares to ensure that the cover remains at the original agreed limit. But neither of this happened.

Instead, the Essel group management reached an agreement with other lenders, including mutual funds, to get time till around September 2019 to arrange for funds. Meanwhile, closed-end funds such as FMPs that have either just matured or are coming up for maturity in the next two months are in a bit of a soup. As and when they recover their money from the Essel Group of companies, they will pay it back to investors.

Those IL&FS securities where recovery is uncertain have been provided for (fund houses have written them off) in the meantime. That’s a loss. On the other hand, fund houses are still holding out a glimmer of hope that Essel group companies will pay up.

Back in January, as far as Essel group debt securities are concerned, fund houses had no choice. There were 44 lenders at the time that had collectively lent Rs 13,500 crore.

According to what was heard on the Street at the time, four lenders that had lent around Rs 200 core collectively were known to have sold the Zee group shares around 25 January that led to the share price collapse. ZEEL’s share price closed at Rs 319.35 on 25 January, down from Rs 434.10 a day before and Dish TV’s share price closed at Rs 22.6, down from Rs 33.60 a day before. If just four lenders could cause such havoc, we can only imagine what would have happened to the stock had all 44 lenders- that had collectively lent Rs 13,500 crore-- dumped their Zee group pledged shares.

Why not mark down the security?

But here’s the tricky part. Kotak AMC- and we hear other fund houses are set to do the same- has not marked down the security. The fund houses reiterated that they have valued the securities as per the valuations that the two rating agencies- Crisil Ltd and ICRA Ltd- provide on a daily basis to all fund houses.

Ideally, when a security defaults- which the two Essel Group companies did (or merely postponed payment, depending on how you’d like to look at it) - the fund houses are supposed to mark down the security and the net asset value shows a loss. Here, Kotak AMC tells us that the affected fund houses voluntarily gave an extension to the Essel group up to around September 2019 to come up with the money.

Hence, this is not a default, fund houses say. This means, on paper, investors have not suffered a loss; they’ve just got a part (most, actually) of their payment now, from all the other assets that the FMP sold off, and the remaining payment will come as soon as the fund houses recover the dues. More so because the fund houses say they are confident of the sale of Essel group assets and recovery of their own dues. But is that the right thing to do?

To dissuade us from telling lies, our parents used to teach us that it takes a thousand lies to hide one lie. Because you have to tell two lies to protect one, then four lies to protect the two and so on….till it becomes unmanageable. The fund industry’s mess reminds us of this. It was bad enough that they decided to take undue risks.

Then the situation got out of their hands when they couldn’t sell the pledged shares. Too many shares had got pledged by then so asking for more cover was not a viable option. If they sold the shares they already had and the share prices would have collapsed. With very little room left to manoeuver, they had to give an extension.

Will mutual funds get their money back?

Only time will tell. The Essel Group may have good brands, so there could still be hope of recovering money, but things could go either way. Mutual funds have to go back to their drawing board and assess how much risk they ought to take. Meanwhile, fund managers who stayed away from taking credit risks- and lost out to many of their aggressive peers in recent years- are now having the last laugh.

Whichever way you look at it, an FMP was never a proxy for a bank fixed deposit, even though they lock in the yields at the start. FMPs are good, but to think of all of them as bank FD alternatives is naive.