Are You Holding Debt Mutual Funds With Stressed Assets?
Feb 28, 2019

Author: PersonalFN Content & Research Team

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Are you investing in a debt mutual fund scheme that shrugs its fiduciary responsibility?

"Mutual Fund Investments are subject to market risks, read all scheme related documents carefully before investing", is the standard disclaimer.

But does this give a license to mutual fund houses to play with your, the investor's, hard-earned money? No, but the recent instances of high exposure to mutual funds of troubled companies' leaves room for suspicion. This article isn't about singling out schemes with high exposure to troubled companies. It's more about unmasking failures and learning from them.

Companies such as DHFL, IL&FS, Reliance Media Works, Reliance Infrastructure, and Zee Entertainment among others have been in the news lately either for financial distress or for poor governance practices.

Some mutual fund schemes (rather mutual fund houses) have not only failed in identifying the danger, but they are also perhaps refusing to learn from their past mistakes. Are there more shades to this? Let's find out...

Table: Who will pay for betting on the wrong horse?

Company/Group Exposure (Rs in crore)
Vedanta group 20,624
DHFL 6,252
Reliance ADAG 3,885
IL&FS and subsidiaries 713
Data as on January 31, 2019
(Source: ACE MF)

The table above suggests that these mutual fund companies have invested Rs 31,473 crore in companies that are in the news for the wrong reasons. This might look minuscule considering the Rs 12.15 lakh crore of Assets Under Management (AUM) of debt funds.

[Read: Is Your Investment In Debt Mutual Fund At Risk?]

The problem lies in the holding trends and patterns.

Consider this: According to the data available on ACE MF, debt mutual funds collectively had an exposure of Rs 6,252 crores to DHFL as on January 31, 2019.

Surprisingly (or not so surprisingly) DHFL Pramerica Mutual Fund has invested Rs 364 crore in a company where DHFL is the promoter. And, as you may know, DHFL is surrounded by the cloud of dubious corporate governance practices.

As on January 31, 2019, DHFL Pramerica Ultra Short Term Fund held 34.7% of its portfolio in DHFL debt. Agreed that at the time of investing, the proportion to debt securities of DHFL may not have been as high as this; but now that it is more than one-third of the total corpus, paints a scary picture.

It seems the scheme was forced to sell other liquid (and perhaps better-quality assets) to handle redemptions. And, this happens to an ultra-short-term fund which is considered less risky.

Are we living in la-la land?

In fact, this is not just a one-off case.

DHFL Pramerica Short Maturity Fund has an exposure of 14.9% to DHFL.

DHFL Pramerica Low Duration Fund held 13.6% of its total portfolio in debt securities issued by DHFL.

And now, DHFL wants to exit the mutual fund business in the pretext of "selling non-core assets" --a pet term of promoters of troubled companies.

As you might be aware, DHFL Pramerica Mutual Fund was a joint venture (50:50) between DHFL and Prudential Financial Inc. (PFI).

If DHFL caught investors and credit rating agencies unaware, it was no different in the case of IL&FS.

The mutual fund industry has swung into a face-saving mode after the IL&FS fiasco came to the limelight in September 2018. Barring a few mainstream debt funds that follow the accrual strategy, most others have managed to get rid of IL&FS debt (either partially or fully) from their portfolios.

[Read: How IL&FS Rating Downgrade Will Impact Your Mutual Funds]

The weightage of IL&FS Tamil Nadu Power Company Ltd. in Aditya Birla SL FTP-OW-1245D-(G) was 4.3% as on January 31, 2019. Moreover, that of IL&FS Transportation Networks Ltd. in the portfolio of Kotak FMP-183-1204D(G) was 3.7%.

It is not that mutual funds only failed to identify financial weaknesses or corporate governance issues. They are perhaps missing the bigger picture. They don't seem to have problems with companies having a questionable history of corporate governance.

Anything for a better yield might be the approach. This is just a guesstimate (or rather observation and certainly not an allegation) based on their investment disclosures.

Apparently, there's no problem with the financials of Vedanta Group companies to which debt mutual funds have significant exposure. However, the promoters of Vedanta recently made a mockery of good corporate governance practices.

Promoters of the Vedanta Group made one of their subsidiaries buy their personal stake in another company. With this transaction, they systematically utilised shareholders' money to serve their personal agenda. Mutual funds collectively have an exposure of Rs 20,624 core to Vedanta group. Unfortunately, they turn a blind eye to promoters with self-serving motives.

Are there any habitual risk takers?

Mutual funds collectively have an exposure of Rs 3,885 crore to Reliance ADAG companies, of which 6.3% is of DHFL Pramerica Mutual Fund alone. Interestingly, Reliance Nippon Mutual Fund's exposure to DHFL is massive 23.3% of the industry's exposure to DHFL.

Axis Mutual Fund has investments to the tune of 8% of the industry's overall exposure to DHFL. It would be interesting to see if Axis Bank has opened its credit lines to DHFL.

Are mutual fund houses promoted by two troubled entities are helping each other in bad times? Why should investors suffer is the question? Many of you may not like the answer, but that's the price investors pay for ignoring the risks involved in debt funds.

Undoubtedly, risks stem from weak finances of companies issuing debt; but risks also have their roots in the attitude of mutual fund houses. There's a thin line between overconfidence and ignorance.

Surprisingly, Franklin Templeton Mutual Fund accounts for 34.3% of the industry's total exposure to Reliance ADAG group companies. In the past, Franklin Templeton Mutual Fund had burnt its fingers in the Amtek Auto and Jindal Steel and Power Ltd (JSPL). Merely a coincidence?

The coming few weeks will decide the fate of Reliance ADAG group companies.

Most of the equity-oriented mutual funds have offloaded their equity holdings in distressed companies such as Reliance ADAG group companies, IL&FS' listed entities, Vedanta group companies, and DHFL among others.

What are the key takeaways?

Some fund houses are habitually assuming significant risks and are taking their investors for granted. It's time for you, the investor, to realise the importance of carefully selecting mutual fund schemes.

Until recently, it was believed that ultra-short term funds and short duration funds are relatively safe. But with new episodes of corporate debt fiasco coming to fore, this assumption is worthless.

[Read: Why Your Money In Liquid Funds Is At Risk ]

All the above instances suggest that, to stay competitive or to outperform, mutual fund houses often forget their mandate and get as greedy as any other inexperienced investor.

It's noteworthy that not all fund houses are making bad investment decisions. The ones following robust investment processes and systems are better off. They don't compromise on qualitative aspects such as corporate governance to accomplish their investment objectives to stick their neck out.

PersonalFN considers all these (and many more) factors while recommending equity and debt mutual fund schemes to its subscribers.

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