Risks in Mutua Funds in India- Mutual Fund Companies or Fund Managers risks


Are you aware of the risks in Mutual Funds in India? Here, I am not discussing the risks associated with products or assets but about the regulatory loopholes which sometimes Mutual Fund Companies use for their benefits and bring us unheard or unaware risks.

Risks in Mutua Funds in India

Today morning I received an email from one of my blog readers as below.

Investors in the Kotak FMP may not receive their full returns in the maturing plan. Would like to get your inputs, as to what can investors do now? Also would like to understand the general risks associated with FMPs.

Let me first give you the story behind this and what is the meaning of Promoters Shares Pledging story.

A promoter of the company means a person who has a controlling stake in a company. When such promoters need the money (for whatever the reason but in many cases, they claim this as for business expansion), they have two options to get the money. One is to sell the stock holdings in the secondary market or pledge the shares with the lenders.

Usually, such promoters holding is in a big way. Hence, if they try to sell it in the secondary market, then the stock price may fall, which in any case they don’t want. Even such a move creates a panic in the stock market or with the investors who are holding such companies stocks.

Hence, to avoid such panic and to protect the fall of stock prices, they choose the second method. Means they pledge their holding of stocks with NBFCs or Banks. In 2009, SEBI mandated public disclosure of promoters selling or pledging their shares.

However, lending against such a pledging is a risky affair for Banks or NBFCs. Because if the share price falls due to any reason (one big reason may itself be pledging of promoters shares), then the value at which the lenders lent may fall to such level that it is hard for the lender to recover the money.

However, whenever there is such a steep fall, it is informed to promoters to pay the margin of the fall to protect the lenders. However, if the promoters fail even to pay such margin of the fall amount, then with no other options, lenders have to sell the stocks in the secondary market. This again makes it further fall in the stock price.

To avoid such risks, RBI places certain restrictions on banks and NBFC’s for loans against shares. The rules relating to margin requirements that need to be maintained, as well as system-wide exposure. The Reserve Bank of India actively monitors these loans. This is to maintain the stability of the financial system.

Now this story is about the share pledging by promoters with Banks and NBFCs. As you may be aware of Banks and NBFCs comes under the purview of RBI. Hence, RBI came up with stricter rules and monitoring mechanism.

However, now the story I am sharing with you is something different. This is the story where Mutual Fund Companies lent the money to these promoters DIRECTLY or INDIRECTLY. Even though Mutual Fund Companies comes under the SEBI Regulations, sadly SEBI never felt it necessary to monitor or regulate such bad practices of Mutual Fund Companies. It is because everything was going well just up to a few months back.

What I learned from the media reports is that SADLY there is no such regulation by SEBI which may forbid the mutual fund companies in pledging the shares of promoters directly or indirectly.

Hence, Mutual Fund Companies started to float their own set of rules and risk mitigation theories and started to lend to promoters directly or indirectly.

Here, directly in the sense, few AMCs lend their debt portfolio money to promoters and indirectly means they invested in the debentures of few companies which are secured against the pledged shares.

Why Mutual Fund Companies or Fund Managers take such risks?

If the mutual fund companies or fund managers aware of such risks, then why they take at the cost of investors money?

The reason is simple, they have to show some alpha over the benchmark or peers. Hence, they take such undue risks which in many cases may not be tracked by we the retail investors.

The reason is that there are no such strong disclosure norms or fund houses feel it is not necessary to disclose the same with FAITHFUL investors about such changes.

Risks in Mutua Funds in India- Are you prepared for Mutual Fund Companies risks?

Such a risky call by fund managers or mutual fund companies is not new. If I remember properly, the first such instance was when Amtek Auto defaulted the payment and which impacted many debt funds during 2015.

Once more such heavy impact was when one Liquid Fund fell almost around 9% in a single day due to Ballarpur Industries Limited (BILT) credit rating was downgraded. I have written a post on this already. Refer the same at “Is Liquid Fund Safe and alternative to Savings Account?“.

In 2018, IL&FS Transportation Networks delayed repayment of Rs 450 crore of inter-corporate deposits from SIDBI. In August, IL&FS Financial Services defaulted on it’s Commercial Paper (CP) but honored it a few days later.

During that period itself, there was an issue of DHFL. Due to DHFL issue, the fund managers were forced to sell the holding due to redemption pressure. Thus making it a permanent loss who redeem in panic.

Now let us come back to the issue where my reader mentioned about one more default.

Kotak Mutual Fund company withheld the part of its redemption in one of the FMP which matured. Two Essel Group companies in which the FMP had invested had not repaid in full. That forced the mutual fund company fund manager to hold part of the payments when the plan matured on 8th April 2019.

Because of this, fund managers now in the hardest situation where neither they can sell the pledged shares (as it creates panic and downfall of price) nor they can say NO to investors where their FMP was already matured. Hence, they withheld the payment in the expectation that Essel Group companies will pay the dues at the earliest.

As per this report, Nilesh Shah, managing director of Kotak Mahindra AMC, said that in return for forbearance on selling the collateral against the Essel Group companies’ debt, the AMC has secured additional concessions. “We have taken personal guarantee of Subhash Chandra, the promoter of Essel Group, over and above Zee Entertainment shares for better security. We have also secured upside sharing on a graded basis on stake sale in Zee over and above the coupon rate of the existing debentures,” he said. The Essel Group has put 50% stake in Zee on the block to raise money and repay debt.

It is not the case with Kotak AMC only. HDFC AMC postponed the maturity of one of it’s FMP from the 15 April 2019 to 29 April 2020 by quoting reasons which neither I can understand nor you. Because there is no clarity in their reply.

This is not the case with only one or two AMCs. Majority of AMCs have holdings in DHFL exposing of almost around Rs.8,640 Crores of investors wealth.

Same way nine AMCs have exposure in Essel Group of Companies worth of around Rs.8,002.

You can refer the detailed portfolio exposure in this Morningstar India post.

When a company default to repay to Mutual Fund Companies, then there are three options.

# Compensate the loss on their own

# Postpone the maturity or rollover the maturity

# Markdown at market price and book a loss to investors.

Mutual Fund Companies are wise enough. Hence, they do not act on the first option. Rather they play with remaining two options and making us the investors to suffer.

Hence, it is we the investors have to bear the heat of such adventures acts of mutual fund companies.

What investors do now?

Sadly nothing MUCH. Because there are no such stricter regulations from the regulator to report any small changes in the portfolio to investors nor there is any particular guidance on how fund managers can take a call by prioritizing the investor’s interest at first.

Hence, finding this loophole, many AMCs playing with us and showing us certain fancy numbers to lure the investors.

It is hard for me and for you also to track such instances easily. If our idea is to track such minute change in portfolio, then we might have done on our own rather than investing in MUTUAL FUNDS. We are unable to handle the investment on a daily basis. Hence, we are handover this task to an expert at a certain cost.

If they are not truthful with their profession, then it is the duty of the regulator to safeguard the investors. However, in many instances regulator opening their eyes only when such bad instances happen. Then they think about regulating or bringing in the transparency in the industry.

Let us hope for the best and wait for some transparency and regulation from both mutual fund companies and regulators. However, I strongly suggest you that to cross-check your debt funds portfolio cautiously once in a while. Because debt funds are more complicated than equity for the layman to understand.





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