Around two months ago, investors in Fixed Maturity Plans, or FMPs, got a rude jolt.
Numerous fund houses (ABSL, HDFC, Franklin Templeton, ICICI Prudential, Reliance, Kotak Mahindra, SBI, Bank of Baroda) have exposure to the Essel Group. The Group had got into a ‘standstill’ agreement with the mutual funds in January, assuring them of a resolution of its financial troubles by September.
So in April, Kotak Mutual Fund informed its investors that it would not be able to redeem certain FMPs maturing then, because of their exposure to debt papers issued by companies belonging to the Essel Group.
HDFC Mutual Fund extended the redemption date in some of its FMPs by a little over a year.
Now the AMC is in the news again. This time, to soothe investors’ nerves. The fund house is providing a liquidity arrangement to certain FMPs that have exposure to the NCDs of the Essel Group. This is for the NCDs that matured in April or will mature as long as the standstill agreement is in force.
Naturally questions abound…….
If HDFC AMC absorbs the FMP loss, is it not the case of the interest of the FMP investor as against shareholder interest? Must shareholders bear the responsibility of wrong investment calls? On the flip side, this might enhance the credibility of the fund house which should be beneficial to shareholders over the long term.
If companies default, must shareholders bear the losses? Or, in this case, is it required because of the breach of contract with FMP investors, with regards to non-payment on due date.
Is this now going to be a precedent? Will investors expect this going forward?
What exactly is 'prevailing valuation'. More specifically, in which case will purchase date or maturity date be employed?
KAUSTUBH BELAPURKAR, Morningstar India’s head of fund research, and RAJAT SHARMA, founder of Sana Securities, answers questions. The views of MANOJ NAGPAL are those that he shared on CNBC TV18.
Should shareholder money be used to purchase the NCDs?
Rajat Sharma: We talk of integrity, then why frown when it is displayed and shown by shareholders or business owners? Would you not have appreciated if, say, a private company led by a single-family promoter, say Piramal or Kotak or Aditya Birla, done this? Every fund house must act in such a way. Am I saying that every time market-related risk shows up they will have to make good? Of course not. But certainly when the judgement of management is clearly the culprit and bad quality paper was purchased.
Manoj Nagpal: If the management agrees on a standstill arrangement, the responsibility of the mutual fund trustees is to the investors of the schemes. The management made a side agreement, and now the shareholders must bear the brunt of it.
How do you view this from the viewpoint of an investor in the FMP?
Kaustubh Belapurkar: Thinking purely from a mutual fund investor’s perspective, this is a good move, especially in the case of FMP investors who were expecting full maturity proceeds to be returned back to them. As far as sentiment goes, this also makes for a good move. The AMC has sought to address the negative sentiment that is persisting in the market. It is due to this negative sentiment that most fixed income fund categories have seen outflows, with the exception of Liquid/Overnight and Money Market funds.
Is a precedent being set?
Kaustubh Belapurkar: No. We do think this is a one-off undertaking which HDFC Mutual Fund has done to address the bad sentiment prevalent in the industry and market, at the moment. This should be an exception, not the norm. And it should certainly not set a precedent where investors expect the AMC to bail them out every single time a bond undergoes stress. This was done in the past, in 2007, but now exposures are much larger.
The note from the AMC mentions “prevailing valuation as on respective maturity/purchase dates”. Any views from an AMC perspective?
Kaustubh Belapurkar: HDFC AMC, as a lender to Essel, would have done their analysis in terms of the probability of recovery of these dues and accordingly taken this call, which also potentially signals that a resolution for Essel may be around the corner. We would need clarity on the valuation at which these bonds are to be purchased. The bonds in question have been downgraded from A+ (SO) to BBB (SO) since the start of 2019, which could mean an impact on the valuation at which the bond is purchased.
Why is there is a limit of only Rs 500 crores?
Manoj Nagpal: If you look at the debt securities the Essel Group owned by HDFC Mutual Fund, it totals to around Rs 1,150 crores of debt securities. Of which, only Rs 491 crores worth of it are impacted till September 30, 2019. Rs 500 is what is to cover in this window.
The prevailing valuations means the current face value. When the Rs 491 crores of debt is passed on to the AMC books, they get a cover of 1.5x, which is approximately securities of around Rs 750 crores. It is up to them to exercise the option now or after September 30, 2019.
