During October, the Indian mutual fund industry narrowly averted a systemic meltdown of its debt funds. Investors were redeeming their investments in large amounts, and the fund companies were running out of ready cash to honour these redemptions. The root cause of the problem was very simple. The fund companies were running debt funds of various types from which investors could withdraw money at any time. However, investors’ funds were invested in bonds that weren’t easy to redeem quickly. Most such funds kept some part of the assets in instruments that should have been easy to sell quickly. However, when the crisis broke, the normal definition of ‘easy to sell’ also broke down. As businesses started panicking, the volume of redemptions also rose way above normal.
In this exclusive interview, the debt fund manager of a large mutual fund house spoke to Dhirendra Kumar, CEO, Value Research about what was happening and how things were managed. The fund manager spoke with complete frankness and honesty–something that isn’t normally possible for someone in his position. In exchange, we’ve promised to keep his identity a secret.
Have you ever witnessed such a crisis in your entire professional life?
Over the last twelve years, we have seen all kinds of crisis. In all those periods we have survived. We have seen call money market move from 0 per cent to 100 per cent. We have seen our fund size coming down by 60-70 per cent in March, yet we consistently survived year after year. There was one difference though. They were predictable and we were able to gear up for it.
This time when the systemic liquidity disappeared, it caught our portfolio managers unaware. We were not prepared for the six sigma event. The liquidity crisis was genuine. We had three month to five month maturity portfolios, but our investors could have taken the money out probably on a daily basis. Was this an error? Yes. Could we have predicted this? The answer is no.
First it was a crisis of liquidity. Then, it became a crisis of confidence. The latter hurt more than the former. Without any basis, people were writing reports that mutual funds are going to default. However, because of the regulator’s support and the systems’ support we have all survived and no mutual fund has defaulted on any obligations.
When did you realise that you were being hit by a crisis?
Probably around the end of September. Despite advance tax payments ending on September 15, redemptions continued. By the end of September our cash balances started dwindling and it hit us that we were in a crisis.
What did you do?
In the initial stages, we used our cash balances. We were lucky enough to have reasonable cash balances, but as the cash balances started dwindling the focus was on selling. Fortunately for us we were able to liquidate portfolios, but after paying a price. Obviously the loss was not placed into the fund, but it was borne by the AMC.
So selling the securities and existing cash balances helped us survive to some extent. Even after these measures we couldn’t see any slow-down in redemptions. Then we had no option but to solicit regulatory support.
Could you not have had a word with your investors?
Of course we did. But what do you do when irrationality prevails? Some of our investors whom we serviced for a decade and with whom we are completely transparent and disclose our portfolios totally acted quite foolishly. They admitted that they were actually comfortable with our portfolios but someone higher up decided to pull out because of the bad publicity. One would not expect such an irrational decision from a non-retail investor.
The top brass didn’t have any problem except that they wanted to avoid bad publicity. I’ve heard of a big corporate which redeemed from a Fixed Maturity Plans (FMPs) which had an all-Certificate of Deposit (CD) portfolio and transferred the money into the very bank whose CDs they were! So what was the corporate governance standard in this company, which takes a loss of capital but moves exposure to the same bank eventually? This is completely absurd.
So what has been the real loss to investors?
The real loss to investors has been on the FMP side. In a liquid fund they got away at the NAV which protected the capital and return. I think the FMPs are the only places where the investors have reacted in panic and taken away their money even at a loss.
What is really unfortunate is that the actual loser was the retail investor, because this same set of investors would now need a lot of conviction to enter back into a mutual fund. They won’t realize their mistake. That it is their stupidity that has resulted in the losses. Instead, they blame the mutual fund.
That is because the retail investor is provided with an indicative return when he invests in FMPs.
True. We have indicated a return based on certain portfolios, but that return holds only on maturity. It is not there for in-between periods. If the market has moved against us, then in no way can I protect the investors who are redeeming right now. I need to be fair to the investors who are leaving me and the investors who are staying back with me.
What was worst point in the whole crisis period?
Personally and professionally, the worst part was when a lot of corporates opted for the path of least resistance and withdrew money knowing fully well, that each of their redemptions would take us to the crisis point.
The moment in time when we hit our lowest was when the people we trusted, were friendly with and had a rapport within corporate treasury who did not stand by us. All we wanted was for them to make a rational decision and stand up for us in front of their bosses.
They could have done that. They could have told their higher-up that they did not have a problem with this mutual fund. They could have shown the portfolio, revealed our track record. We always worked for them and never against them, they knew it. Our fund managers actively advised the customers to shift from income funds to liquid funds as the interest rates were rising. We even put their interest ahead of our fees.
Yet, when the rubber hit the road, they just shrugged their shoulders and took the convenient way.
Was there anything else you could have done?
I still wonder about that. I have tried to figure out what else we could have done to give them the confidence.
Who initiated the idea of RBI support?
I am not privy to all these things. But I think all of us have some contact on a personal and professional level within Securities & Exchange Board of India (SEBI), Reserve Bank of India (RBI) and Ministry of Finance. And each one of us used those contacts to pass the information on that the pressure was daily building up.
How did they move?
Eventually, Association of Mutual Funds in India went (AMFI) to SEBI, and the two approached the RBI to get the nitty gritty worked out. The regulator behaved like a responsible parent. They helped us! They worked overnight, they responded quickly and that’s why we all survived. If there was any delay in regulatory support we would have been finished. All this was operationalised in less than 48 hours.
What has been the learning with regard to your investment portfolios?
Our investment portfolios now would be geared for six sigma event not just for normal day-to-day operations. We will have to restructure our portfolio in a manner that the maturity mismatches come down to bare minimum. We have to ensure that mark-to-market of our portfolios are around 90 or 30 days, instead of 182, so that the risk is transferred to the client. There is no way now the asset management company will stand as a guarantor, taking all the risk and giving all the returns. The risk and return both would be passed on to the customer.
Then do you see investors, who have flocked to banks, coming back?
Eventually they would. We were giving them value. We were giving them any-day liquidity vis-à-vis a minimum 7-seven day lock-in by the banks. We were giving them comparatively better returns for most part of the year, compared to the banks. That is essentially because our intermediation cost is much lower. Surely some people will come back but that will take some time.
And then they will have to come back on newer terms and conditions which may not be as favourable to them as before. They will have to get used to the new regime, which will be lower returns with the attached risk. The purity of product structure will make our future products less attractive than the current products, as we will be bundling the risk and the return together. All along, the returns were passed on and risk was absorbed by the AMC.
Will the changes translate into some products getting disbanded?
We probably have an extended range of products. They were created to cater to the niche requirement of the customers rather than the mass requirement of the customers. Now, as the focus shifts back to mass rather than the niche, the products would disappear.
We have a liquid fund and a liquid plus fund. But do we really require all the plans? We were rolling out FMPs for 1 month, 3 months and 6 months every other day. We won’t be doing that again.
In FMPs, we were providing customers with an exit option. Going forward that may not remain. The FMP is a close-ended fund so you come here with a lock-in premise. I cannot allow premature withdrawals. So a lot of the impurities that have got into the system will clear out.
How has this entire crisis changed the perception of your fund house towards investors?
We were dealing with corporate treasury giving them the best of service, the best of returns and taking all the risk on our own account. And when the crisis came, they walked away.
On the other hand, we have retail investors who lost 50 per cent of their money in the equity crash and are still giving us money. Somewhere the industry focus would shift from AUM gathering to getting quality investors in.
So there will be a change in the business model?
It would have to change. Till now we were using the third party network to reach our customers and we were garnering larger AUM with a select set of customers and using that as income to fund the retail model.
Our strategy was pull based where we thought our transparency, disclosure and professional expertise would pull money in the fund. And on this front we have succeeded reasonably, but not up to the scale that we would have liked to. The penetration of the mutual fund industry, compared to the insurance industry, which came later, is very low. Moreover our ability to retain the customers for a long period of time is quite pathetic.
Has thinking started at the owners’ level that this is not the business worth doing?
Definitely. Most AMCs have got huge support from their sponsor, that’s why they are surviving today. Whether the support came in the form of losses to be absorbed by the AMC or whether the support came in the form of investments in liquid or mutual funds. But without the support of the sponsors no one would have survived.
The sponsors put money at 9 per cent or 10 per cent of return when their own cost of borrowing was 15 or 16 per cent. And now they are realising that this business does not make sense. They would rather run a business that is profitable than one which is going to get valued on percentage of AUM.
Were other mutual funds hit by the external crisis or was it the result of extreme internal indiscipline?
To be fair, barring one or two mutual funds where the credit side of the portfolio is debatable, all the mutual funds have shown an exemplary track record and credit worthiness. Most have not erred on the maturity side also. It is not that in our liquid fund we have got a 10-year maturity vis-à-vis say one-day liability. However, when the crisis came the difference was sponsor support.
What has happened with fund houses like Lotus and Mirae Asset?
In the case of Mirae Asset, the sponsor was not willing to absorb the loss. In Lotus’ case, probably the same thing happened. Since they were not willing to take the loss or provide liquidity, they had no option but to sell out. All mutual funds today are surviving and prospering based on sponsors’ support.
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