Recent Developments Bring Some Relief in Sight for Debt Fund Investors

Jul 17, 2020

After weeks of turbulence, India's debt market is witnessing some calm and stability aided by RBI's measures, such as lowering of interest rates, conducting long-term repo operations, purchases of government bonds, etc. The government too stepped in to extend credit line and collateral-free loans to boost financing options for corporates. These measures by the central bank and government have started to bear fruit.

Some strong indicators highlight improved debt market conditions. Banks are now parking lower funds in RBI's reverse repo window, which points out to increased lending and lowering of risk aversion by banks. Further, yields on corporate bonds and commercial papers have dipped by up to 30 bps after RBI's record rate cuts.

Moreover, media reports suggest that sales of riskier bonds rose to a 15-month high in June, rebounding sharply from April-May levels on the back of stimulus. All this has helped in the ease of raising capital and reduced borrowing cost for corporates.

Debt mutual funds too have benefitted from the stimulus. Banks deployed around Rs 8,000 crore (from their own resources and through RBI's special liquidity facility) in mutual funds to ease liquidity.

Here are some other recent positive developments in the debt mutual fund space:

1) UTI MF receives entire money from ZEE Learn

Recently, I had mentioned that troubles were mounting for investors in debt schemes of UTI MF. The fund house had decided to create a side-pocket for its exposure to ZEE Learn Limited (ZLL) in two of its debt schemes -- UTI Credit Risk Fund and UTI Medium Term Fund following rating downgrade. These funds already have segregated portfolios for its exposure in Vodafone-Idea (VIL) and  Altico Capital.

UTI Credit Risk Fund had an exposure of 9.11% of its assets, worth Rs 40.7 crore as on June 30, 2020, to debt papers of ZLL, while UTI Medium Term Fund had an exposure of 3.03% valued at Rs 3.4 crore.

ZLL was liable to pay the NCD obligations in Debt Service Reserve Account (DSRA) 30 days prior to the due date. In case of any shortfall in servicing debt obligations, Zee Entertainment Enterprises Limited (ZEEL) was supposed to pay the balance amount at least seven days prior to the due date, i.e. July 02.

However, neither ZLL nor ZEEL had funded the DSRA account as per the structure. Given the company's non-adherence to the structure and non-funding of the shortfall in NCD obligations, CARE decided against giving the benefit of Credit Enhancement to the NCDs.

ZLL had filed a petition in Bombay High Court seeking moratorium on NCD payments. However, HC ruled that RBI's moratorium provisions cannot be granted to debentures, mutual funds.

Subsequently, the fund house has received the entire payment amount along with interest accrued till date. The recovered amount will be credited to the unitholder's bank account (or through physical warrants in case bank details are not available) in proportion to their holdings.

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2) Franklin Templeton ramps up recovery process in wound-up schemes

If you recall, in June Franklin Templeton MF (FTMF) had received interest payment from 8.25% Vodafone-Idea bond maturing on July 10. The six schemes of FT that were wound-up had exposure to the said paper of Vodafone-Idea (VIL) in its segregated portfolio. FT had processed the interest payment to the scheme's investors in the proportion of their holdings.

FT has now received full payment of principal from the said bond, which will be soon distributed to unitholders.

In another positive development, FT has received the Delhi High Court's nod to sell pledged shares of ZEEL and Dish TV (both part of Essel Group). The shares were pledged to FT against the Rs 425 crore non-convertible debentures (NCDs) of Essel Infraprojects which matured on May 22, 2020. Essel Group has defaulted on the payments of the said NCDs prompting FT to invoke the pledge on shares. Four shuttered schemes of FT have exposure in the security.

So far, the wound-up schemes have received a total amount of Rs 3,275 crore since April 24 from maturities, pre-payments, and coupon payments. The six schemes are expected to receive Rs 3,200 crore more in cash flows by September.

However, there is no update on the voting process to be concluded for the shuttered schemes. The fund house can initiate monetization and distribution of assets to unitholders only after successful completion of the voting process.

The road ahead for investors in debt funds...

Though debt market conditions have improved, there are still challenges, especially for low-rated securities given the economic uncertainty and bleak outlook. Therefore, it would be prudent to stay away from funds with high exposure to private issuers. Invest in debt funds that have predominant exposure to government bonds or quasi-government papers because these can offer better safety and liquidity.

[Read:Why You Need To Be Extra Careful While Selecting Debt Mutual Funds Now]

To select a scheme, essentially assess your risk appetite and investment time horizon, plus factors such as:

  •  The portfolio characteristics of the debt schemes

  •  The average maturity profile

  •  The corpus & expense ratio of the scheme

  •  The rolling returns

  •  The risk ratios

  •  The interest rate cycle

  •  The investment processes & systems at the fund house

In the current scenario where interest rates seem almost bottomed out, you would do better going with low duration funds such as pure Liquid Fund and/or an Overnight Fund that does not have high exposure to private issuers.

At PersonalFN, we arrive at top rated funds using our SMART Score Model. If you wish to select worthy mutual fund schemes, I recommend that you subscribe to PersonalFN's unbiased premium research service, FundSelect.

Additionally, as a bonus, you get access to PersonalFN's popular debt mutual fund service,  DebtSelect.

If you are serious about investing in a rewarding mutual fund scheme, Subscribe now!

Warm Regards,
Divya Grover
Research Analyst

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