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New Safegaurds For MF Investors!

Published on Sat, Jan 16,2016 | 16:23, Updated at Mon, Jan 18 at 18:32Source : CNBC-TV18 |   Watch Video :

Mutual fund investments are subject to market risks, read all scheme related documents carefully. Most investors pay heed to that warning only when investing in equity mutual funds. But debt funds are often perceived to be safe. So last year when JP Morgan’s debt schemes fell into trouble - it served as a wake up call for investors, the mutual fund industry and the regulator. Last week SEBI announced new prudential guidelines for mutual funds. Do they fix all these problems? Not quite says Sajeet Manghat.

On August 7th 2015, credit rating agency CARE suspended its rating of Amtek Auto. The auto component manufacturer had till then enjoyed a AA (minus) rating on Rs 7644 crore of bank loans and Rs 1880 crores of non-convertible debentures.

CARE said it suspended the rating because the company had not provided adequate information. At the time JP Morgan AMC was the only mutual fund that owned Amtek paper. Two of its schemes had invested a total Rs 193 crores in Amtek debentures. The investment amounted to 15% of one scheme and 5% of the other.

A month later – in September 2015, Amtek Auto defaulted on the interest payment on its debentures. Net Asset Valuess of the two JP Morgan schemes fell and investors rushed to redeem their units.

JP Morgan responded to the panic run by imposing a redemption restriction – investors were allowed to redeem only upto 1% of the schemes’ units on any given day.

The fund’s move drew severe criticism and regulatory intervention. After consultation with market regulator SEBI, JP Morgan asked unit holders for approval to segregate the Amtek investments from the schemes and eventually sold the paper for reportedly a quarter of its value.

The 2 months of high drama forced a sharp fall in the schemes’ values and raised several issues for India’s Mutual Fund sector!

JR Varma
Professor, IIM Ahmedabad
Chairman, Risk Management Review Committee, SEBI
“There were several of them, one was large exposure to one single entity, very large investment in Amtek Auto that is one risk that came up. The second risk was that when the company got downgraded, the bond prices in the market, there wasn’t really enough trading to disclose a proper price for the bond. Therefore the net asset value (NAVs) were not representing the price at which you could sell. Therefore redemptions became a problem. If somebody redeemed the bond they redeemed at NAV but the NAV was not the price at which the assets could have actually be sold and therefore investors who stayed back in the fund lost out to those who redeemed.”

62% of India’s $190 billion mutual fund investments are in debt schemes. That’s Rs 7.88 lakh crore of a total of Rs 12.74 lakh crore of assets under management. Insiders say only a fraction of that is invested in high yield paper such as Amtek debentures.

Lakshmi Iyer
Chief Investment Officer (Debt) – Kotak AMC
“If you actually see the credit rating profile for these schemes a predominant chunk of this is actually in the AAA and equivalent assets. The only place where there is non AAA exposure or the category would be at the mu tual fund industry level could be about a lakh, lakh and a half crore which is the high yield or the accrual category funds.”  

MFs: NEW SAFEGUARDS

EARLIER
MF Scheme can invest maximum 25% in debt of single issuer
Limit applied to individual debt categories
ie: 25% in money market instruments of X + 25% in debentures of X + 25% in….

NOW
MF Scheme can invest maximum 12% in debt of single issue
12% limit on combined exposure to money market & non-money market instruments of same issuer

MFs: NEW SAFEGUARDS

EARLIER
Additional exposure limit to HFC debt = 10%

NOW
Additional exposure limit to HFC debt = 5%

MFs: NEW SAFEGUARDS

NEW
25% limit on Scheme’s exposure to a business group

But that 15% exposure was enough to prompt market regulator SEBI to put in place new safeguards. So far a mutual fund scheme could invest a maximum 25% of its money in the debt of a single issuer. The limit applied on debt categories. For instance the fund could invest up to 25% in money market instruments of an issuer and another 25% in debentures of the same issuer.

Last week the regulator reduced that limit to 12% and also capped the combined exposure to money market and non-money market instruments of a single issuer, at 12%. The additional exposure limits for debt instruments of housing finance companies has been reduced from 10% to 5%. And SEBI has also introduced a new 25% limit on a scheme’s exposure to a business group. The new prudential guidelines have drawn mixed responses.

Lakshmi Iyer
Chief Investment Officer (Debt) – Kotak AMC
“It cannot be one size fits all so you cannot have a 10 plus 2 which is the 10 percent per issuer or limit, can go up to additional 2 percent that is 12 percent with the trustee approval. It may not be appropriate to have it across the credit rating curve. There is a perception implied expectation of a AAA credit performance over a non AAA and as you go down the curve the implied risk only increases so, that is where probably some more measures may need to evolve.”    

JR Varma
Professor, IIM Ahmedabad
Chairman, Risk Management Review Committee, SEBI
“There is a catch there and to realise the catch one only needs to go back to the subprime crisis of 2008. Where did the losses come? They all came in AAA rated paper. So, the issue in credit is that the problem is in fact greater in instruments which you think are safe and turn out not to be safe.

In fact when you buy a low rated paper at least what is happening is that you are getting higher coupon and even if there is some distress you can at least say that okay for three years I earned a higher interest rate which compensates me for some of the losses that are happening. In AAA what really happens is that you are getting very low interest rates and if that gets downgraded then you are eating the credit loss as well.”

Sajeet Manghat - CNBC- TV18
“However, good they are, these new safeguards may not prevent all future crisis. Yet Securities and Exchange Board of India (SEBI) has not issued any guidelines on what to do if that happens. The JP Morgan episode was the first time that a mutual fund has used redemption limits or gating and segregation or side pockets. However, the regulator is silent on whether these can be templates for future crisis.”

Lakshmi Iyer
Chief Investment Officer (Debt) – Kotak AMC
“Gating to some extent senses out a lack of confidence in the investor fraternity at large. It does not impact your right as rightly mentioned in the fund house but in certain cases the gating is necessitated given the nature of the underlying corporate bond market which as I just mentioned to you is quite illiquid in India. May not be, I would say the most appropriate solution. A better solution in a credit kind of a scenario probably would be a quarantining kind of a thing where you create a separate NAV out of it till such time that there is a solution created.”

The other area that needs immediate attention is the regulation of credit rating agencies. The sudden suspension of Amtek’s rating by CARE and a drop to default rating by BrickWork drew criticism even from peers.

Ananda Boumik – MD, India Ratings & Research
“I think the biggest risk from a market and a regulatory perspective was obviously the jump to default. The fact that ratings moved down several categories, that clearly is not acceptable by any standards. It is actually, a possibly a disservice that any rating agencies could do to the markets.”

After the JP Morgan fiasco, SEBI met with ratings agency to warn them about industry practices such as sudden rating changes, suspension of ratings and ratings shopping.

JR Varma
Professor, IIM Ahmedabad
Chairman, Risk Management Review Committee, SEBI
“When we evaluate the performance of a rating agency, we measure not only that you had AAA rating and how many of those AAAs defaulted. Probably none did, it is very rare for AAA company to actually default. However, we also ask how many of them got downgraded and you would also say that AAA getting downgraded to AA is fine. If you are talking about 5-10 years then getting downgraded to A is also fine. However, if it gets downgraded beyond that or like you are saying you are get a 6 notch downgrade quickly that is also will count as a failure.”

More scrutiny and new regulations may help curb such ratings practices. On the other rating shopping may be an outcome of too much regulation. Fund managers are not allowed to invest in instruments rated below AA. For many issuers that cuts out an important source of funding. And so they go shopping for that AA!

Ananda Boumik – MD, India Ratings & Research
“All that money out there essentially follows AAA and AA so to some extent it distorts pricing there. However, beyond a AA so for example if an issuer is rated AA and gets downgraded to AA minus or A plus which by any standard is a very reasonable circumstance which could happen because of various reasons. However, the moment that happens that paper becomes immediately illiquid and that is because of regulations. I think the time has come to give fund managers a greater leeway and to have a system where fund managers can openly talk about their risk appetite.”

SEBI may need to do much more to safeguard against a repeat of the JP Morgan Amtek episode. As do fund managers. Because when such a crisis occurs or is about to occur, alert institutional investors are often the first to redeem. They exit at NAVs that may not have fully adjusted to the reduced asset value. And retail investors are often left carrying the can! Should funds be asked to compensate investors who stayed behind during a credit risk event? Or should that fall upon the credit ratings agency?

JR Varma
Professor, IIM Ahmedabad
Chairman, Risk Management Review Committee, SEBI
“If you knew that the bond was illiquid and that its valuation was suspect and you allowed large investors to redeem from there then you would be liable to make up the loss. So, it is up to you to figure out and to demonstrate that on the day that you allowed the redemption you did not have a material reason to suspect the carrying value of the asset. That obligation should be put on them and that material information can come from many sources.

If the stock price has dropped 35 percent then I would think that there is a material reason for the funds to start thinking about whether the credit risk has been impacted. You can’t just say rating agencies said nothing.”  

Sajeet Manghat - CNBC- TV18
“SEBI’s new prudential guidelines may only be the start of more action to prevent another JP Morgan – Amtek Auto episode. There is also a view emerging that like credit ratings should mutual fund schemes also be rated to communicate the degree of risk associated with them. It is not clear how much that would help. The best say is that investors remember that mutual fund investments are subject to market risks, read all scheme related documents carefully and now we know that applies to debt and equity investments.”

 
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