Debt Funds Crisis: ILFS, Zee, DHFL, Ballarpur, JSPL

Investing in debt funds isn’t risk-free. However, debt funds investors don’t expect the Net Asset Values (NAVs) of debt schemes to fluctuate like equity funds. Debt Mutual Funds have exposure to Zee group Debt papers(₹8,000 crore), IL&FS debt papers( ₹ 2,308 crores) and Dewan Housing Finance Corporation (DHFL) (8,500 crores) group companies. What began as a singular event, with IL&FS defaulting on its dues, has snowballed into a liquidity crisis for many Non-Banking Finance Corporations(NBFCs) since October 2018.  Zee, DHFL, IL&FS crises not only show poor corporate governance but the debt funds are ridden with risks. Many of the funds had to mark down some of their schemes’ portfolios by about 25% to 100% of the value of the underlying securities as companies either saw a sharp fall in their credit rating or didn’t return the principal. Defaults will force fund houses to mark down these investments as well, impacting their net asset value or resorting to side-pocketing, separation of stressed assets. These Debt funds created a crisis of confidence not only among the investors of the two schemes by JP Morgan but the industry as a whole.

Debt mutual fund is Not risk-free

Debt funds are not risk-free(unlike Fixed Deposits). Debt Mutual Funds mainly invest in a mix of fixed income securities such as Government Securities, Treasury Bills,  Corporate Bonds, Money Market instruments and other debt securities of different time horizons. Mostly Debt securities have a fixed maturity date & pay a fixed rate of interest. Debt securities are also assigned a credit rating, which helps assess the ability of the issuer of the securities/bonds to pay back their debt, over a certain period of time. These ratings are issued by independent rating organisations such as CRISIL, CARE, FITCH, Brickwork and ICRA. The returns of a debt mutual fund are dependent on

• Interest income
• Capital appreciation/depreciation in the value of the security due to changes in market dynamics

Debt funds come with two kinds of risk:

• Interest rate volatility: When interest rates move up or down. if Interest rate moves up, debt fund NAV also moves.
• Credit risk: When credit rating of instruments drop or defaults on interest and principal repayments. Rating agency CARE downgraded ratings for DHFL’s debentures, bonds and fixed deposit on February 3 from AAA to AA+. When bonds of DHFL still enjoyed the highest rating of ‘AAA’, they were quoting at a yield-to-maturity (YTM) of 11-12 per cent for a 5-7 year residual maturity enjoying a steep premium to other AAA-rated bonds in the market. AAA-rated bonds of 5-year tenure trade at a YTM of 8.4-odd per cent, while AA-rated bonds trade at 8.9 per cent.

There have been instances where if a problem occurs with any underlying security in a debt fund, the asset management or the sponsor company bought the troubled paper from the debt fund and paid the money back to the MF scheme.

But in the last few years, this has not happened. Whether it is JP Morgan India Asset Management (Amtek Auto Ltd), Taurus Asset Management Co. Ltd (Ballarpur Industries), or in the present IL&FS case, fund houses did not take the hit on their own books. They let the scheme take the losses and that is why the NAVs in all these cases fell.

What began as a singular event, with IL&FS defaulting on its dues, has snowballed into a liquidity crisis for many Non-Banking Finance Corporations(NBFCs) since October 2018.  Zee, DHFL, IL&FS crises not only show poor corporate governance but the debt funds are ridden with risks. Many of the funds had to mark down some of their schemes’ portfolios by about 25% to 100% of the value of the underlying securities as companies either saw a sharp fall in their credit rating or didn’t return the principal. Defaults will force fund houses to mark down these investments as well, impacting their net asset value or resorting to side-pocketing, separation of stressed assets. These Debt funds created a crisis of confidence not only among the investors of the two schemes by JP Morgan but the industry as a whole.

Side Pocketing

The Securities and Exchange Board of India (Sebi) has allowed debt mutual funds to have a “side pocket” that will allow fund managers to segregate their holdings in stressed assets. A side pocket is a type of account created to separate illiquid funds from the more liquid ones.

In September 2015  Amtek Auto defaulted on repayment due to liquidity issues. The move forced the JP Morgan fund house to segregate the Amtek Auto holding into separate units at face value of Rs 10, popularly known as a side pocket. One set of units contained the investments made in Amtek Auto Ltd (side pocketed units) while the other set of units contained all other investments and cash holdings. These side pocket units were shut for redemptions till Dec 2015. In Dec 2015 JP Morgan fund house was able to sell Amtek papers and then the investors could redeem the units.

How are Debt Fund investors reacting?

Although the situation is slightly tricky, given the unusual uneasiness in the credit markets at present, investors need not panic. Unless, there’s an official announcement on delinquencies, redeeming investments from the schemes offered by affected fund houses based on speculated news is unwarranted.

According to the AMFI data, investors have withdrawn a massive Rs 84,511 crore from income funds and invested Rs 61,220 crore in liquid and money market mutual fund schemes over the last six months.  By and large, investors are shunning income funds and parking their savings in liquid and ultra-short term funds. Ref: Personal Fn

In the wake of the diminishing credit quality lately, fund managers of responsible fund houses might have already started taking corrective measures. This includes paring exposure to low-rated papers, not relying excessively on independent credit agencies, and realigning their portfolios keeping in mind scheme’s defined objectives among others.

As explained in the Economic Times article, 5 things you must check before investing in a debt mutual fund

High exposure to low-rated bonds: It is imperative investors have a closer look at the credit break-up of a debt fund’s portfolio and invest only if comfortable with the quality as indicated by credit rating profile

High exposure to the single issuer: Funds are not allowed to hold more than 10% of net assets in securities of a single issuer but be wary if a fund invests more than 7%. Some debt funds are known to take high exposure to instruments issued by a single entity. This increases the risk profile of the fund. For instance, before the IL&FS episode unfolded in September, liquid fund Principal Cash Management had Rs 102 crore invested in the troubled bonds—9.8% of its total assets. The fund’s NAV slipped 5.72% in a single day on 24 Sep 2018, wiping out its entire gains over the preceding year.

A chunk of the portfolio invested in a single group: Sebi restricts group-level exposure in debt schemes to 20% of the net assets, which may be extended up to 25% subject to approval by trustees. Investors should avoid putting money in funds that have cumulatively invested more than 15% of the portfolio across instruments issued by a single group. However, it is difficult for the investor to ascertain the extent of group level exposure as fund houses do not disclose this information.

DHFL Crisis and Debt Funds 2018-19

Fund houses such as Aditya Birla Sun Life Mutual Fund, L&T Mutual Fund, Kotak Mutual Fund, Franklin Templeton Mutual Fund etc have exposure to DHFL or its group companies. Indian fund houses have exposure of over Rs 8,500 crore to Dewan Housing Finance Corporation (DHFL) group companies. Of the total amount, around Rs, 7,100 crores is invested in debt papers of DHFL by around 292 debt schemes, while the remaining is invested in Wadhawan Global Capital, Avanse Financial Services and Aadhar Housing Finance.

UTI Mutual Fund has investments of around Rs 2,144 crore in various group companies of DHFL Group across 51 debt schemes. Reliance Mutual fund has an exposure of Rs 1,488 crore in DHFL. The image below shows the DHFL crisis

Zee Crisis and Debt Funds Crisis 2019

Indian Mutual fund houses have an exposure of about Rs 11,000 crore to the Essel Group companies, the parent company of Zee. Most of the Mutual Fund debt exposure to Essel Group companies is through debentures and zero coupon bonds(ZCB).  While there are 13 equity schemes with over 2% exposure to Zee Ent., 150 debt fund schemes have exposure of over Rs 8,000 cr to various promoter cos. The Aditya Birla Sun Life Mutual Fund is the biggest investor, with an exposure of Rs 2,936 crore spread across 28 schemes. This is almost 37% of the total debt fund exposure to the Zee group.

In Jan 2019, In an open letter, Subhash Chandra, chairman of Zee and Essel Group, had expressed difficulties in repaying its lenders last week. The deterioration in Subash Chandra-led Essel Group’s financial position led it to reach an agreement with lenders, mainly NBFCs and mutual funds, for an eight-month breather. The group now has time till Sept. 30 to find a strategic partner and deleverage its Rs 13,500 crore debt burden—Rs 11,000 crore of which is from mutual funds and NBFCs.  On Jan 27, 2019, the lenders asserted their belief in the intrinsic value of ZEE Entertainment and Dish TV, resulting into the following decisions:

• There will not be any event of default declared due to the steep fall in price.
• As a result of the above, there will be synergy and co-operation, amongst lenders leading to a unified approach.
• Lenders drew comfort from reiteration by the promoters for a speedy resolution through a strategic sale in a time-bound manner.

Take a look at the 15 schemes with maximum net asset % debt exposure to Essel Group entities

Company Name	AMC Name	Scheme Name	Instrument	Market Value	% of Corpus Dec 2018
Sprit Infrapower & Multiventures	HDFC	HDFC FMP – June 2016 (36) – 1 – 1128D	Debentures	9.48	11.95
Edisons Infrapower & Multiventures	HDFC	HDFC FMP – June 2017 (38) – 1 – 1136D	ZCB	10.75	11.68
ARM Infra & Utilities Pvt Ltd.	HDFC	HDFC FMP – June 2018 (41) – 1 – 1124D	ZCB	50.84	11.41
Sprit Infrapower & Multiventures	HDFC	HDFC FMP – May 2016 (36) – 1 – 1127D	Debentures	13.55	11.33
Sprit Infrapower & Multiventures	HDFC	HDFC FMP – July 2016 (36) – 1 – 1161D	Debentures	6.77	11.26
Edisons Infrapower & Multiventures	HDFC	HDFC FMP – February 2016 (35) – 2 – 1148D	Debentures	44.26	11.04
Konti Infrapower & Multiventures	Kotak	Kotak FMP – Series 194 (1099 Days)	ZCB	23.62	10.95
Konti Infrapower & Multiventures	Kotak	Kotak FMP – Series 183 (1204 Days)	ZCB	61.40	10.73
Konti Infrapower & Multiventures	Kotak	Kotak FMP – Series 193 (1098 Days)	ZCB	26.25	10.53
Konti Infrapower & Multiventures	Kotak	Kotak FMP – Series 187 (1146 Days)	ZCB	51.06	10.48
Edisons Utility Works Pvt. Ltd.	Kotak	Kotak FMP – Series 187 (1146 Days)	ZCB	50.92	10.45
Konti Infrapower & Multiventures	Kotak	Kotak FMP – Series 127 (730 Days)	ZCB	45.93	10.36
Edisons Infrapower & Multiventures	HDFC	HDFC FMP – February 2016 (35) – 1 – 1161D	Debentures	86.09	10.34
Primat Infrapower & Multiventures	ICICI	ICICI Prudential FMP – S 80 – 1138 Days – Plan R	ZCB	16.81	10.24
Sprit Infrapower & Multiventures	Birla	Aditya Birla Sun Life FTP – Series OW	ZCB	9.39	10.23

Equity mutual funds have invested Rs 2,719.43 crore in the stock of Zee Entertainment Enterprises as on December 2018. Another group company, Essel Propack, and Dish TV India have got investments by mutual funds of Rs 75.04 crore and Rs 122.86 crore, respectively. Mutual funds hold Rs 37.38 crore in the stocks of Siti Networks as on December 2018

13 schemes individually have more than 2% exposure to Zee Entertainment stock. The funds with the biggest exposure include Tata India Consumer Fund, Invesco India Large-cap Fund, Tata Multicap Fund, Reliance ETF Consumption, ICICI Prudential Equity Savings Fund, HDFC Charity Fund For Cancer Cure – Arbitrage Plan and Aditya Birla Sun Life Resurgent India Fund – Series 3.

Fund	% Net Asset	Amount Invested (Cr)	No. of Shares
Tata India Consumer Fund – Regular Plan	4.18	60.99	1280000
Invesco India Largecap Fund	3.57	6.12	128555
Tata Multicap Fund – Regular Plan	3.02	43.83	920000
Reliance ETF Consumption	2.94	0.36	7518
ICICI Prudential Equity Savings Fund	2.72	55.56	1166100
HDFC Charity Fund For Cancer Cure – Arbitrage Plan – Regular Plan	2.64	3.53	74100
Aditya Birla Sun Life Resurgent India Fund – Series 3 – Regular Plan	2.33	3.81	80000
Invesco India Dynamic Equity Fund	2.13	22.33	468684
Principal Focused Multicap Fund	2.09	6.48	135900
Tata Value Fund Series 2 – Regular Plan	2.09	5.34	112000
Tata Value Fund Series 1 – Regular Plan	2.08	15.25	320000
DSP Equal Nifty 50 Fund – Regular Plan	2.07	2.54	53354
Aditya Birla Sun Life Tax Relief 96	2.03	146.52	30752

IL&FS Crisis and Debt Funds in 2018

IL&FS, the infrastructure finance company in India, had racked up over Rs 90,000 crore debt and recorded defaults in 2018. This led to credit rating agency downgrade on a major portion of IL&FS and its group companies’ outstanding debt.  While some debt fund schemes wrote off their investments in IL&FS after it was downgraded, it did not end there. Some mutual fund schemes marked down 20-25% of their investments in road SPVs of IL&FS after they did not pay interest citing a moratorium by the NCLT leading to a downgrade by rating agencies. Several mutual funds including DSP Credit Risk Fund held IL&FS debt and had recorded sharp drops in NAV (Net Asset Value).

Our article What is IL&FS Crisis? Why the Government had to rescue IL&FS covers IL&FS crisis in detail.

In 2015, when JP Morgan AMC was facing the issue of severe rating downgradeand potential default by one of the exposures in their portfolio, namely Amtek Auto.  JP Morgan AMC side-pocketed the Amtek Auto exposures, which was there in two of their funds, and allotted units accordingly, of the “good fund” and the “bad fund” for the sake of simplicity.

Taurus Mutual Funds and Ballarpur Industries 2017

On 22 February 2017, net asset values of four of  Taurus Asset Management Co. Ltd debt schemes fell 7-12% in just one day as The credit rating of Ballarpur Industries, India’s largest maker of paper products, in which its debt schemes had invested, was downgraded that day from A3 to A4 by India Ratings & Research, a credit rating agency. Ballarpur Industries has defaulted on repayment and the fund house has written down the entire value of the scrips. The Four schemes were Taurus Liquid Fund, Ultra Short Term Bond Fund, Short Term Income Fund and Dynamic Income Fund. Investors in Taurus were allowed to redeem their investments from these schemes.

Franklin Templeton, ICICI Pru and JSPL Crisis Feb 2016

ICICI Prudential Mutual Fund, Reliance Mutual Fund and Franklin Templeton Mutual Fund had  Rs 2,600-crore exposure to the papers of the company from the troubled steel sector, Jindal Steel & Power (JSPL).

The debenture issuance by JSPL offered a coupon rate of 10.48 per cent. In Feb 2016 rating agency Crisil had downgraded JSPL’s long-term rating from BBB+ to BB+ with a cautionary note that the group’s liquidity would deteriorate significantly in the near-term as the stake sale in a rolling mill and the receipt of the proceeds from the settlement in Bolivia might take longer.

Franklin Templeton Mutual Fund has an exposure of Rs 2,100 crore in JSPL group, while ICICI Prudential AMC has nearly Rs 500 crore of exposure and Reliance group had 49 crore exposure. Although the latter’s overall exposure is merely 0.31 per cent of its overall debt assets under management, one of its schemes — ICICI Prudential Regular Savings Fund — has 2.91 per cent of its Rs 5,245-crore asset size in JSPL’s debt instruments as on Feb 2016.

In Mar 2016, Franklin Templeton Asset Management Company completely exited its exposure to Jindal Steel and Power Ltd (JSPL) after downgrading of the debt papers of the Naveen Jindal-led group’s firm. Franklin exited from four JSPL securities maturing over the next two to five years at Rs 67.5 per bond as against a face value of Rs 100. This was about Rs 7.50 lower than the price at which it sold securities worth almost Rs 890 crore in February.

JP Morgan and Amtek Auto Crisis 2015

In 2015, JP Morgan 2 MF schemes together had an exposure of Rs 200 crore or 6.75 per cent of total assets under management in debt issuances by Amtek. The shares of  Amtek Auto lost 70 per cent on the stock exchanges in August, to a six-year low. The rating agency withdrew its rating on these debt instruments, after rating them quite high earlier.

In Aug 2015, JP Morgan Mutual Fund had restricted redemptions from two of its debt schemes: Short Term Income Fund and India Treasury Fund. The move followed a decline in NAVs (net assets value) of the schemes due to the fund house’s exposure to troubled auto component firm Amtek Auto’s debt papers

In September 2015  Amtek Auto defaulted on repayment due to liquidity issues. The move forced the JP Morgan fund house to segregate the Amtek Auto holding into separate units at face value of Rs 10, popularly known as a side pocket. One set of units contained the investments made in Amtek Auto Ltd (side pocketed units) while the other set of units contained all other investments and cash holdings. These side pocket units were shut for redemptions.

In Dec 2015, JP Morgan Asset Management Company managed to sell the debt papers of Amtek Auto to a private equity firm at a 15 per cent loss. Then JP Morgan allowed the unitholders holding units of segregated assets in schemes — JP Morgan India Treasury Fund and JP Morgan India Short Term Income Fund to place redemption requests.

Related Articles:

• What is IL&FS Crisis? Why the Government had to rescue IL&FS
• Debt funds and Fixed Deposit, Debt Funds offer stability and liquidity
• Short Term Capital Gains of Debt Mutual Funds, Tax, ITR
• Long term Capital Gains of Debt Mutual Funds: Tax and ITR

Excessive debt continues to haunt Indian business houses. But will investors pay the price for the corporations’ and Mutual Funds bad business decisions is the question? Credit risk is a very real part of investing in debt funds. Investors should be concerned about how much risk are Debt Funds really taking?  Debt funds are meant to provide safety and not multiply wealth. Investors should stick to funds with high-quality assets, preferably holding at least 80% in AAA or equivalent rated securities