6 min read.Updated: 20 May 2019, 09:40 PM ISTNeil Borate
You may lose the chance to participate in NAV recovery if you exit the schemes now
As fund managers have indicated, DHFL has so far been servicing its debt and there has been no default
Exactly a week ago on 14 May, CARE Ratings downgraded the borrowings of Dewan Housing Finance Corp. Ltd (DHFL), a housing finance company, worth a huge ₹1.13 trillion. These borrowings included long-term bank facilities, a fixed deposit programme, perpetual debt, subordinated debt and non-convertible debentures (NCDs). Out of this, NCDs, debt instruments that evoke interest from retail investors accounted for ₹46,655.12 crore. The NCDs were downgraded from CARE A to CARE BBB- (credit watch with negative implications). According to CARE Ratings, CARE A signifies ‘low’ credit risk, while CARE BBB signifies ‘moderate’ credit risk.
The CARE Ratings downgrade came just three days after rating agency CRISIL downgraded commercial papers issued by DHFL worth ₹850 crore on 11 May. CRISIL downgraded the commercial paper from CRISIL A3+ to CRISIL A4+ (ratings watch with negative implications).
The DHFL downgrade may have widespread implications not just for investors in NCDs, but also for mutual fund investors, given that as many as 164 schemes across 23 asset management companies (AMCs) are exposed to DHFL papers. Total industry exposure to DHFL alone (excluding group companies) is ₹5,183 crore, as on 30 April 2019, according to data provided by Value Research. In absolute terms, UTI Asset Management Co. has the highest exposure to DHFL papers, followed by Reliance Nippon Asset Management Ltd.
More worryingly, schemes in relatively ‘safe’ categories such as corporate bond funds are highly exposed in percentage terms, even in cases where absolute exposure is low. Corporate bond funds are mandated to hold 80% of their assets in debt with the highest credit rating and are perceived as relatively safe. Among such funds, Tata Corporate Bond Fund has 28.21% exposure to DHFL, far above the single-issuer exposure limit of 10% mandated by capital markets regulator Securities and Exchange Board of India. The fund ranks fourth among funds having exposure to DHFL in terms of percentage of scheme assets, with the top three slots being occupied by funds of DHFL Pramerica Mutual Fund, which is co-promoted by DHFL (see graph). However, DHFL is in talks to sell its stake in the AMC.
The rapid set of downgrades for troubled groups like DHFL appears to have caught such schemes off-guard. “As liquidity dries up, it becomes difficult to sell lower-rated papers. Instead, highly-rated liquid papers are sold off to meet redemptions," said Vijai Mantri, chief investment strategist and co-promoter, JRL Money, a wealth management firm. This can cause the share of lower-rated papers to cross the Sebi-mandated 10% upper limit.
Three fund managers, who spoke to Mint on the condition of anonymity, indicated that credit ratings agencies were being excessively cautious in this case. “The paper is still technically ‘investment grade’ and no default has yet occurred with DHFL. The ratings agencies may be ‘overcompensating’ for their earlier lack of action in case of IL&FS," said the first fund manager from a private AMC.
They also indicated that the real risks lie in non-banking finance companies (NBFCs) and housing finance companies that are still marked as AAA. “The market has already factored in the downgrade into the price of DHFL paper and this in turn has already caused net asset values (NAVs) of debt funds to drop," said the second fund manager. As a result, retail investors may not face further loss of value unless there are more downgrades.
DHFL Pramerica Medium Term Fund, which has a 37.42% exposure to DHFL (as on 30 April), saw a 2.7% drop in NAV over the past week, taking its one-year return to just 0.81% (as on 19 May). In cases where exposure in individual schemes is high, experts indicated that it was due to outflows from the schemes in question, resulting in more liquid papers being sold to meet redemptions. “Our exposure to Dewan is in the form of secured NCDs and the company has been regular in debt servicing till date. So far the company has been using the securitization route and cash inflows from the existing loan book to repay its liabilities. Also, a large part of the book is retail lending and as per recent exchange intimation, the collection efficiency on this book remains at around 99%," said Murthy Nagarajan, head (fixed income), Tata Asset Management Ltd.
Reliance Nippon AMC released a statement that implied it may have pared down some of its exposure since April. “Currently, we have an outstanding exposure of ₹680 crore in secured listed NCDs, mostly maturing in the very short term," said a spokesperson from the fund house. “The company has been regular in meeting all commitments and has made significant debt repayments in the past few months," he added.
Industry body Association of Mutual Funds of India (Amfi) has released guidelines on ‘haircuts’ to be taken by AMCs on papers marked BB or below. It specifies a haircut of 20% if a paper issued by a financial institution is marked BB. However, if the market price trades lower than this haircut, the market price is to be taken. DHFL paper has not yet been downgraded to a level for which the Amfi guidelines can apply. A downgrade below investment grade rating also makes a scheme eligible for side-pocketing, which in short is segregation of a certain number of units in a scheme against bad debt. However, most AMCs have not set into motion the process required to enable side-pocketing. According to experts, this is partly because side pocketing is a ‘change of fundamental attribute’. The AMCs have to provide investors an exit load-free period allowing them to leave when there is a change of this nature. This can cause ‘undue alarm’ among investors.
Some industry leaders have begun to advocate avoidance of risky credit categories of debt funds. At the launch of the BSE Star Mutual Fund Platform on 15 May, Sunil Subramanian, chief executive officer, Sundaram Asset Management Co., said “IFAs should not sell credit risk funds to all but the most savvy investors." Neeraj Choksi, joint managing director, NJ India, a large mutual fund distribution firm said, “Generally, we don’t sell credit risk funds. We sell equity, arbitrage and liquid funds."
However, the presence of risky debt in relatively ‘safer’ categories like corporate bond funds and hybrid funds has placed this hypothesis in some doubt. Some experts say that the retail investors should avoid all but the safest debt fund categories. “Even corporate bond funds can take exposure to debt below AAA up to 20% of assets," said Amol Joshi, founder, Plan Rupee Investment Services. “In some cases, they have taken on fairly risky papers for the extra yield. Ordinary investors should stick to liquid and ultra-short funds. The difference between them and riskier categories is marginal when it comes to returns over long periods of time," he said.
If you are holding units in schemes that have already been hit by the downgrade, exiting at this stage may not serve any purpose. As fund managers have indicated, DHFL has so far been servicing their debt and there has been no default. If you redeem the investment at this stage, you may be losing the chance to participate in the recovery in NAV, if any.
For investors in all categories of debt funds, this is the time to evaluate the risks in the portfolio of the schemes. Pay particular attention to concentration risks, whether in an issuer, group or sector and exit if the scheme does not hold a well-diversified portfolio. This does not apply for bonds issued by the central and state governments. Look at the credit rating profile and be aware of the credentials of the borrower, especially where the fund has a greater exposure. Seek the help of an advisor if you are unable to make the evaluation on your own and protect your portfolio as far as possible from unexpected events.