The problem with inter-scheme transfers in debt MFs

Credit risk funds have encountered a wave of redemptions in the wake of the Franklin Templeton fiasco. Battling a liquidity crunch, fund houses are resorting to inter-scheme transfers of bonds to repay investors. Here is why you should be concerned. Faced with redemptions, funds first tap their own cash reserves. When that tap runs dry, they look to sell off bonds in the secondary market to generate cash. However, in adverse market conditions, the secondary market doesn’t provide any succour—liquidity practically disappears, particularly for lower rated bonds. Most debt funds avoid selling off the more liquid, higher grade bonds in the portfolio. So as a last resort, funds may approach banks to borrow some money. Most fund houses avoid this route as it could entail a hit on the fund’s returns. The only way out for stressed funds to generate liquidity in such circumstances is to arrange for transfer of securities within their own schemes. Termed as inter-scheme transfer, it involves one fund selling securities to another fund from the same fund house.Over the month of April, credit risk funds sold bonds worth roughly Rs 5,500 crore to sister schemes. ICICI Prudential AMC, HDFC AMC, Kotak AMC, Aditya Birla Sun Life AMC, SBI AMC and Nippon India AMC are among the fund houses that carried out the transfers. This is not a new phenomenon. Inter-scheme transfers have been going on for many years. There is nothing wrong with such transactions these are permitted by the regulator as long as the transfer occurs at a fair value as determined by a rating agency. A transfer is frowned upon if it happens at a price which hurts the interest of investors in either scheme. “As long as the investments are done according to scheme objectives, it should not matter whether that exposure is coming from a primary or secondary market transaction or through inter-scheme transfer,” argues Amit Tripathi, Head-Fixed Income Investments, Nippon India Mutual Fund.Credit risk funds have sold mostly AA rated bonds to sister schemesInvestors in funds receiving such bonds must remain vigilant.76104234Figures for the month of April. Data compiled by Pulse LabsHowever, even when such transfers fit into the broader mandate of the receiving fund, it must be noted that many of these are illiquid bonds. Data compiled by Pulse Labs shows that the bulk of the transfers have been of AA rated bonds. Further, most of the transfers have been into hybrid schemes—a preserve of conservative investors. For instance, ICICI Prudential Mutual Fund transferred bonds worth Rs 2,207 crore from its credit risk offering to ICICI Prudential Balanced Advantage, ICICI Prudential Equity & Debt and ICICI Prudential Multi Asset. HDFC AMC transferred securities worth Rs 1,782 crore to HDFC Hybrid Equity and HDFC Hybrid Debt, among other debt schemes. Kotak AMC arranged some transfer into Kotak Savings while ABSL shifted bonds to ABSL Balanced Advantage and ABSL Equity Hybrid, among others.Experts point out that a spike in lower rated bonds in the portfolio may materially alter the risk profile of the receiving fund—both in terms of credit risk as well as liquidity risk. A few fund houses may be dumping their bad assets to low risk profile schemes, putting their investors at risk. Prateek Pant, Head – Products and Solutions, Sanctum Wealth Management, says, “Even if these transfers fall within the ambit of the law, they may not be in the spirit of the law. Fund houses have used the back-door to shift lower rated bonds into defensive schemes.” In April portfolios, some hybrid funds have suddenly seen appearance of lower rated NCDs and perpetual bonds. AMCs may perceive hybrid funds as ideal candidates to house these bonds as the higher volatility in equity segment can mask any value erosion in the debt portion.Several of the AA rated bonds sold belong to issuers with strong fundamentals. Papers transferred include those issued by the likes of Muthoot Finance, Tata Motors, Godrej Properties, among others. These companies are backed by healthy operating metrics or strong parentage. The likelihood of these defaulting on their obligations is remote. Some fund managers insist that the AA papers in fact spell a great opportunity for buying schemes. “In the wake of events in April, the AA-rated segment of debt markets got priced at a steep spread, providing the best risk-return payoff,” points out Manish Banthia, Senior Fund Manager – Fixed Income, ICICI Prudential AMC. He insists ICICI Prudential Balanced Advantage bought these bonds from various market participants considering the attractive valuations and as part of its shift towards debt in its regular rebalancing exercise.However, not all the AA names are in good financial shape. Among the issuers whose bonds have been shifted, Shriram Transport Finance has been put under rating watch. Piramal Enterprises reported net loss to the tune of Rs 1,703 crore in the March quarter. Some A-rated securities have also been shunted to other schemes. These include Avanse Financial Services, Security and Intelligence Services, Syndicate Bank, to name a few.Experts say investors in funds receiving such bonds must remain vigilant— particularly if they belong to a category perceived to carry lower risk. If the proportion of such papers in the overall portfolio rises beyond a certain level, it should be a cause for alarm. “It should not happen that one set of investors are saved at the cost of others,” avers Pant.

from Economic Times https://ift.tt/2ZWnyfF