There have been discussions recently on HDFC AMC providing ‘liquidity’ to a few Fixed Maturity Plans (FMPs) by agreeing to purchase the questionable exposure in certain Essel Group entities. This purchase comes in the background of increasing asset quality issues in the mutual fund industry, question marks on the loan against securities (LAS) exposures to the Essel Group companies and the extension of the tenures of the FMPs by HDFC AMC. We need to understand the background to put the occurrence of these events in the right context.
Mutual Funds are market-oriented investment vehicles. Any loss in the portfolio, be it due to market price movement of securities or default of a debt instrument is to be borne by investors.
Creating uneven competition
We may question the judgment of the AMC on bad investments, but that would be the reason for a separate debate. And there is a rationale for this: the relationship between the investors (unit-holders) and the MF is that of a principal and agent. The MF acts as the agent of the principal (unit-holder) and invests the pooled money in securities from the market. In case one AMC gives a guarantee about bearing market losses, they will be one-up in the market. For investors’ (i.e. unit-holders’) selection of AMCs, such fund houses will have an advantage, which is not fair competition. As per rules, a Scheme can give a guarantee on returns only if there is a guarantee from the Sponsor of the MF, as distinct from the AMC. So far, this clause has not been used—no MF Sponsor has given a guarantee on returns—since MFs are meant for investments in the market and not bank deposits.
Having said that, there have been occasions in the past where an AMC has taken over/borne the loss of bad investments. These losses are legally meant to be borne by investors. Such moves are purely goodwill gestures. Though investments are made in the market ‘through’ MFs and not ‘in’ MFs, most investors look at it as investments ‘in’ MFs, without appreciating that it is but a vehicle for routing the investments.
In 2015, when JP Morgan AMC faced a repayment issue from Amtek Auto, it passed the risk on to investors, but recovered a substantial chunk of the investments later. In 2015 and 2016, when Franklin Templeton was faced a similar problem with Jindal Steel and Power (JSPL), the exposure was sold to an unknown buyer. But it was ultimately revealed that the buyer was the AMC itself. There is a debate about the pricing of such deals, as the exposure is purchased by the AMC at a discount; hence, if the borrower repays in full on maturity, the AMC will make a profit.
Thereafter, all the problem cases have been passed on to investors: Ballarpur Industries (BILT), IL&FS Group entities, Dewan Housing Finance Limited (DHFL) the Anil Dhirubhai Ambani Group (ADAG) entities, etc.
The Essel case
Now let’s come to the Essel Group LAS(loan against shares) issue. There are many funds, across multiple AMCs, with exposure to various Essel Group companies. When the promoter failed to top-up the pledged shares/pay cash when the share price dropped, it was technically a default. On a particular day in January 2019, when there was selling pressure in the stock and the supply was less than 1 per cent of the outstanding, the share price crashed by around 25 per cent, as potential buyers got wind of the LAS unwinding. In view of this event, for LAS deals that were to mature in March/April 2019, AMCs and NBFCs entered into a ‘standstill agreement’ with the promoter of Essel Group. The promoter agreed to repay the outstanding amount by September 30, 2019. In turn, AMCs and NBFCs agreed to not sell the pledged shares. The tricky part here is that in close-ended funds (FMPs in this case), all the securities have to mature at the same time, unlike open-ended funds where maturities can vary.
The approach to FMPs with troubled exposures has been different across AMCs. Kotak FMPs, with exposure to Essel Group companies matured on due dates in April. The pending amount will be paid to investors September 30, 2019, assuming the promoter of Essel Group honours its commitment. Similarly, certain FMPs of Reliance Nippon AMC matured recently and the amount in question from the troubled exposure to Reliance Home/Reliance Commercial was received a few days later. However, certain FMPs of HDFC AMC, due to mature in April, were rolled over or extended under Clause 33(4) of Mutual Fund Regulations. This led to the question, what if Essel Group entities fail to pay up in September 2019 and whether it is a worthwhile exposure in terms of credit quality. Here comes the rescue from the AMC; the fund house will purchase questionable exposures to the extent of Rs 500 crore to the LAS deals from certain FMPs maturing from April to September 2019.
Questions marks still crop up as to the fairness of the deal to the shareholders of HDFC AMC. However, this move would inspire confidence among investors (i.e. unit-holders) about the commitment to the business and anything good for the business is good for shareholders in the long run.