Illiquid debt investments of IDFC equity funds questioned

Investment research firm Morningstar has raised concerns over two investments made by IDFC’s equity funds in 2010 in an IDFC fixed maturity plan as well as a “sizeable” presence of  illiquid securities in their portfolio in 2008.

“We find such actions disconcerting,” said one of the reports, a review of IDFC Premier Equity Fund dated September 13, authored by research analyst Srikant Subramanian.

The Morningstar review noted that the fund made investments in a close-ended debt fund launched by the AMC last year.
The annual report for IDFC Premier Equity Fund shows a `5 crore investment in IDFC FMP 13 Months Series 5 for the financial year ending in March 2010.

Another report on IDFC Sterling Equity fund highlights a similar investment.

The IDFC Sterling Equity, formerly the IDFC Small and Midcap Equity Fund, invested `5 crore in IDFC FMP 13 Months Series 5, according to the annual report for the financial year ending in March 2010. According to the scheme information document of both funds, they have a mandate to invest up to 35% of their corpus in debt, money market or securitised debt instruments.

However, the reasons given for the two investments are not in the best interest of investors, according to Morningstar.

“The rationale that this was intended to test liquidity conditions for listed close-ended funds suggests an unexpected use of investors’ assets,” said the Morningstar report on IDFC Premier Equity and repeated in its report on IDFC Sterling Equity.

In the downturn of 2008, some of IDFC’s other equity funds
also had sizeable investments in illiquid debt securities, which, while legal at the time, remain “questionable”, according to both reports. 

“Such investments are hard to comprehend. In that period, it wasn’t uncommon for fund companies to transfer illiquid securities from debt funds to equity funds, to facilitate liquidity in the former,” the reports said.

“Irrespective of the source of the illiquid securities in the fund company’s equity funds, the investment practice itself is questionable, since it isn’t in the best interests of the equity fund investors. Also, it does not reflect positively on the fund company,” they said.

The two reports rated the funds ‘superior’, a notch below its highest rating for equity funds. Morningstar termed the rating a reflection of confidence in the fund manager Kenneth Andrade and his investment style.

Andrade, head-investments at IDFC AMC, said the investments were made to maximise returns from its cash holdings.
IDFC Premier Equity Fund has had an average holding of 10% in cash, money market securities or corporate bonds since its inception to facilitate any redemption requests.

“Given the situation with equities at that point in time, our holding of money market/ corporate bonds was well in the interest of investors. Liquidity is a function of market forces at that particular point in time.

The trade worked out in favour of the investor, which has shown up in the long-term performance of the fund,” Andrade said.