My Take on FT Saga: Winding up of 6 Credit Risk Schemes

posted on 24 April 2020 by Sunil Jhaveri

This note may sound like I am trying to defend the indefensible. I am only trying to bring in a very different and a dispassionate view to this entire saga and its implications and repercussions. What has happened has already happened; what we can salvage and communicate with our Investors will make all the difference. Otherwise, entire Credit space and with that Debt schemes of entire Mutual Fund Industry will have existential crisis. We will lose faith and confidence of Investors with huge credibility issues going forward.

Hence, all I am trying to do is Control the Controllable and not concentrate on what is already done and not in our hands. Those who know me, know that I have always found some positive message in any times of crisis be it JSPL, Amtek Auto fiasco, 2013 Income Fund fiasco or 2019 FMP fiasco due to delay by Essel group. 

FT has been managing Credit space over past 10-12 years with great amount of success. They were the inventor of this space which was called Accrual schemes then and now known as Credit Risk schemes post recategorization by SEBI. They have always delivered above average returns in all their schemes so far. One thing they are not apologetic about is them taking credit calls in most of their schemes. For them, this space was as big as Rs.50,000 - Rs.55,000 crores a few months back. Over past few months they have managed to recover Rs.25,000 crores in the bargain reducing this space to almost Rs.28,000 crores currently.

Coming back to current winding up of schemes issue:

This can be compared to recent Essel crisis in some of the FMPs (not exactly in same proportion) and the Fund Houses taking a call to give time to the borrower to repay over extended period of time. This was done to protect the interests of the Investors. Fund houses that time also had two choices: sell shares of Essel group at hugely discounted price (this was Loan against Shares security) and erode principal for Investors or give some time for resolutions and give better value to the Investors. Here also, liquidity was sacrificed to get better value for Investors in future. In this case it was sheer case of default but time was granted to resolve. Also, keep in perspective that period v/s current one which is once in a Century Black Swan period due to Corona Virus issue. 

As far as FT’s decision to wind up schemes is concerned; it is not default, downgrade or delays but more of liquidity crisis created due to COVID lock down, redemption pressures and current illiquidity and lack of risk appetite in Debt market space. Just like I had done an analysis of why AMCs resorted to giving breathing time to Essel instead of selling their shares; let me make readers understand choices and current situation of the markets pre and post Lock Down phase:

Current Debt Market situation:

  • Post lock down in the month of March, debt markets turned extremely volatile and illiquid
  • One day to 3-month rates spiked to astronomical highs
  • There were only sellers and no buyers
  • FPI pulling out from Debt and Equity markets aggravated the situation
  • Advance tax outflows and year end redemptions created further pressures
  • Retail borrowers have been given moratorium of 3 months on their dues but NBFCs from whom they have borrowed have not received the same consideration
  • This will stretch some of the weaker NBFCs, Manufacturing Companies, and many more post lifting of the Lock Down by the Government
  • Economic activities are at a stand still
  • Rating Agencies hands are tied behind their back in as much as they are not allowed to change their ratings for some of these weaker companies during this lock down period
  • Post opening up, there is no certainty of how many companies will be downgraded or will delay or default on their borrowings
  • All this will only put further pressure on Credit space going forward
  • Most Fund Houses do not have as much exposure to Credit as FT has and may scrape through even if they have say, 10% redemption pressure in Rs.5,000 crore scheme v/s 10% redemption pressure on Rs.28,000 crores which can be as high as Rs.2,800-Rs.3,000 crores impact

Post March 2020; RBI announced aggressive rate cuts and liquidity announcement measures and nudged banks to borrow in REPO at 4.40% and invest in 1-3 year-securities (under LTRO). Due to lack of risk appetite, transmission of rate cuts has not materialized. Nevertheless, the FT continued to get redemption pressures in all their Credit space schemes. Fund House had to resort to borrowing to meet redemptions or sell liquid assets due to mispricing of securities and illiquidity attached to the same due to current Debt market situations.

Hence, FT had two choices going forward: 1) sell securities at any price and erode value for the Investors or 2) bide time by winding up these schemes and safeguard value at the cost of liquidity to the Investors. During this period, they will not be charging any Management Fees to these schemes. For the Fund House, it is a major commercial blow.  So far, there have not been significant delays or defaults in these Wound Up schemes. Management feels, that they will be able to exit in timely and orderly fashion through maturities or by sale in secondary markets as and when risk appetite improves and economy limps back to normalcy.

FT has chosen the latter to safeguard interests of the Investors at the cost of delayed liquidity.

Please convey the following to your Investors and bring them some comfort:

  • This is not delay or default and no hair-cuts so far
  • Do not know what will happen post opening of the Economy as stated above
  • This is to give better value to the Investors; at the cost of delayed liquidity
  • NAVs will be announced on daily basis; funds will accrue income, capital gains/loss based on value of underlying security – exactly as they would have if the schemes were open for purchase or redemption
  • Going forward, all these securities will be treated as HTM – and may not have interest rate impact as and when borrowers pay their dues on maturity or
  • FT may sell these securities at appropriate value (maybe at profits as well) if markets normalize and risk appetite of banks is restored
  • Investors should expect better realization of underlying security v/s if FT is forced to sell based on redemption pressures currently
  • Of course, many Investors will be grappling with liquidity issues; but should have the comfort of better realization going forward. But they also should know that these are unprecedented times; never seen before and hence this action
  • This is a once in a century black swan event which has created such uncertainty

If you and I are not able to manage the emotions of the Investors at current juncture and put things in right perspective; instead only instill fear in them and be part of negativity surrounding this event; we will lose confidence, credibility, mind share and even wallet share of these Investors in the Mutual Fund space. That trust deficit will come to only haunt our Industry with huge irreversible damage. This is not the time for blame game. I had requested all AMC CEOs to refrain their RMs from talking against other AMCs when JSPL or Amtek Auto fiasco happened as the same could have happened in their AMCs as well. These are unprecedented times, never seen before, uncertain periods. Let us communicate with our Investors in a responsible manner.