Mutual Fund FMPs hit by defaults: What investors should know
ET Wealth answers 6 key questions on FMP defaults by MFs in order to explain what it means for investors.
What is the problem with FMPs?
Some mutual fund companies which had lent to Zee (Essel) Group entities are holding back payments due to investors in their fixed maturity plans (FMP). Several FMPs that are due for maturity are not able to repay the entire amount. This is because of the delay in recovery from the Zee Group.
Investors in six FMPs of Kotak MF will not be able to redeem the entire maturity value. HDFC Mutual Fund has also informed investors its plan to extend the tenure for one of its FMPs coming up for maturity by another year.
Is my money lost or will it be recovered later?
Investors in affected FMPs of Kotak MF will receive part payment of maturity proceeds for now. They will get the amount equivalent to the value of the other holdings in the FMP (maturity amount minus value of holdings in Zee Group). The remaining amount may be paid if and when the fund house recovers the money from the companies.
In case of the HDFC MF FMP maturing on 15 April, investors can either agree to extension in maturity date or exit on the prevailing maturity date. For investors who exit, units will be redeemed at applicable NAV on existing maturity date. They will get the amount minus the value of holdings in Zee. Investors who agree to extending maturity date may recover the entire amount, provided the entities repay the debt.
Are all FMPs in trouble?
Apart from Kotak MF and HDFC MF, several other fund companies have exposure to debt instruments of the Zee Group. Of the total exposure of Rs 7,500 crore to the troubled entities, around Rs 1,400 crore is held by FMPs. Most of the FMPs with exposure to Zee Group are from the stables of Kotak MF, HDFC MF, Aditya Birla Sun Life MF and Reliance MF.
FMPs coming up for maturity are likely to either roll over the maturity date or delay payments to investors. In some schemes, exposure to Zee Group entities is as high as 20% of the scheme corpus. Investors in these schemes will take a hit.
These FMPs with high exposure to Essel Group are coming up for maturity
Source: Ace MF, Compiled by ETIG Database. *Pertaining to Zee Group
Why are MFs not recovering the money?
Fund houses had lent to the Zee Group entities against the collateral of shares of Zee Entertainment Enterprises. When lending against pledged shares, MFs typically enter into covenants with the borrower (issuer of the debt instruments). The issuer agrees to pledge shares worth up to 1.5-2 times the loan value. If there is a sharp drop in price of the shares, the MFs typically ask the borrower to top up the pledged shares to cover the shortfall in margin. If not, they can recover the money by selling the pledged shares.
In this case, however, most fund houses have not invoked the covenants despite a fall in share price of Zee. They have entered into a standstill agreement with the group promoter till September 2019. By this time, the promoter has promised to sell stake in a few key group companies and repay the debt. Until then, the fund houses have agreed not to invoke the pledge. This is to prevent further drop in share price and avoid hurting sale prospects.
FMPs hit by defaults: What investors should know
What is the problem with FMPs?
What can I do now?
Investors in closed-ended FMPs cannot exit during the tenure of the scheme. While these are listed on exchanges and are, therefore, tradeable, the trading volumes are very poor. This limits the investor’s ability to exit the scheme at a fair price.
When faced with default, if the fund house is offering to extend the scheme maturity date, it is better to agree to the rollover. It gives the investor a chance to get back the full amount on maturity. If not, the investor will have to take a haircut on the maturity proceeds. If the fund house is part-paying on maturity, investors have no option but to wait for the fund house to recover the remaining amount.
Does this make FMPs a bad investment?
No, it doesn’t. But it should remind investors of the credit risk prevalent in FMPs, just like any other debt fund. While FMPs do not carry interest rate risk unlike open-ended debt funds, they do carry default risk. If the credit profile of the scheme portfolio is poor, there is a chance of default in some securities.
Do not blindly invest in an FMP based on any indicative yield suggested by the distributor or adviser either. Higher yield comes at the cost of low-rated or poor quality securities. Being a closed-ended fund, there is no way investors get to know what companies the FMP will invest in at the time of investing. At best, investors may opt for FMPs offered by pedigreed fund houses with a proven track record in managing debt funds.