Financials

Role of Stakeholders In Debt Defaults

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<p>Losses in equities are digestible to investors but then comes losses in long duration debt funds, then short duration debt funds, then in liquid funds and now in FMPs also the loss have been extended and it is unacceptable by the investors. Out of two AMCs, (Kotak) one is redeeming the FMP; so called fund yield less expenses less the investments which are at present defaulted resulting to forget the yield, but erosion in capital. It is using the side pocketing and hopefully in September 2019 they will recover the investments to Essel group and payback to the investors with higher yields. The second AMC (HDFC) is giving the option to clients to roll over with new high yields or to redeem the funds at the current market value and forgo the right of recovery, if it happens and for which the AMCs are very positive for the recovery. In this case, if you are in need of funds, you have to bear the losses and there is no clarity for the future benefits for the same; may either be retained by AMC or the unit holders at that point of time .</p><p>This has not happened for the first time , earlier somewhere in 2013 it was spike in interest rate which resulted to loss in NAV, depending on the duration of the funds. But defaults started in 2015 with JP Morgan and then in 2016 with Franklin Templeton, Reliance and ICICI Prudential. Again 2017 with Taurus. But this time with default of Essel group and IL&amp;FS group, the magnitude is big both in terms of losses and number of schemes; and with more than 10 AMCs, again having major markets share in the industry. One of the AMCs (Reliance) is still confident and have not marked down NAV of the said FMP and are confident to get back their lending to Essel group in time. This issue will keep on highlighting as the deadline given by Essel group to honour the debts is Sept 2019 and many of the FMPs are getting mature before that and will have to take the either route which the two AMCs have taken.</p><p>Let&rsquo;s us understand issue from the point of different stakeholders of the industry. AMC, Advisors, &nbsp;Investors, media and Regulators.</p><p>AMC: The manufacture has to decide that whether they want to be asset managers or asset gatherers. In equities, many a times &nbsp;we have seen the suspension of fresh purchase or suspension of big tickets in specific schemes, if there is no opportunity of investment is found by the fund manager. The same can be applied in the debt schemes also. In order to chase the returns, they must not compromise on the quality of the papers. Genuine, accidental defaults are understood.</p><p>At present, in race to generate returns, history is the proof that the quality is compromised. No hard work is done to really for the risk diligence. Risk management, is found to be in nascent stage.</p><p>Distributors: The truth is that most of the distributors are less equipped to understand the debt products. They are just chasing the returns and demanding that high return type of products putting pressures on AMCs to generate the returns even at the cost of compromising the quality of the papers.</p><p>Both distributors as well as AMC need to understand that investors in debt cannot digest, forget the losses in capital but even 25 bps of loss in the indicative returns. Again, the catch for the distributors is they have been taught and can show the simple formula of portfolio yield less expenses +/- difference in interest rate and duration of the funds. The ratings and default risk were completely ignored, even when the earlier events were signaling the risk.</p><p>In case of FMPs, AMCs are practically not declaring the portfolios for obvious reasons, before the schemes opens and distributors cannot do anything when the portfolio is disclosed, as the schemes are closed for exit options!!</p><p>Investors: They need to forget the free higher returns and understand that higher returns always come with higher risks. In FMPs, when compared to bank fixed deposits one should also understand that there are different interest rates with different banks, within the same set of nationalized banks, private banks and even with cooperative banks, for obvious reasons. I am sure the investors investing in direct schemes without having any external advisories would have to bear more losses.</p><p>Regulators: They are doing the best job so far. But need to be stricter, with all the stakeholders. Recent scheme categorization and name of the scheme representing the characteristic is a welcome step. I have seen the clients asking two more questions when it comes to cheque writing in favor of credit risk funds. Side pocketing demanded in the debt funds may either be removed or implemented only with FMPs or with very high penalties with AMCs and strict audits with distributors and investors too. There are all chances that if AMCs have pressures of returns they may overlook the risk diligence because if something wrong happens then they can shift their responsibilities to side pocketing.</p><p>There should be strict norms for issuing, selling and purchasing the different categories of debt products. One, because the market size is too big when compared to equities and two, the risk appetite is very low and more important to understand, in debt products.</p><p>Media: the job of media should be to communicate the right facts in simple ways. The industry by and large has done a fabulous job. Currently the industry would be managing close to 16 lacs crores in debt and the amount is question is of around 8000 crores, which is a fraction of %age. Again, the default is the delay in the payment. Even the defaulted payments have been recovered from the time of UTI assured returns MIPs to JSPL case. But I doubt even a fraction of space is given to positive events as news item.</p><p>One need to understand that bad debt is the peril in the business of lending. Together, we need to educate the investors and in turn investor should also be ready to understand the risk in investing various financial instruments he is investing and understand the importance of asset allocation.</p><p>To summaries, all the stake holders have to work hand in hand. Everyone is communicating that we are partners in the journey and working in fiduciary capacities, but somewhere it is a selfishness to earn more by all the three stakeholders, which is always at the cost of others, creating havoc in the industry.</p>
KR Expert - Sandeep Gandhi