The recent credit downgrade of Infrastructure Leasing & Financial Services (IL&FS) and its subsidiaries has once again highlighted the uneasiness between the investment objective and the portfolio positioning of various debt mutual fund schemes, especially those of liquid funds.
Liquid schemes are often positioned as a substitute to savings bank accounts. In fact at the recent AMFI summit, one of the key messages showcased by the new investor awareness campaign was -"Mutual fund fixed income schemes mein bhi FD wali baat hai". So, what were some liquid funds doing holding poor-quality debt securities of IL&FS?
The consensus is that fund managers bought securities when they were rated well by agencies and they never felt any signs of trouble at the firms. However, some also say that liquid funds should not compromise on safety and liquidity to compete on returns.
Date with debt
According to Value Research data, liquid funds of at least five AMCs namely LIC, Union, Mirae, HSBC, and Principal as on August 31 together had over Rs 1000 crore worth money invested in commercial papers of different IL&FS entities such as IL&FS Financial Services, and IL&FS Securities Services.
After the credit downgrade news of IL&FS entities spread, MF portfolios were scanned for any potential hit. Some debt schemes posted drop in NAV due to mark down of assets post the rating downgrade. The presence of debt securities issued by IL&FS entities in liquid fund portfolios has triggered a massive debate, and not without a reason. Liquid funds may be popular with institutions, but roughly 11% of the Rs 6 lakh crore in liquid/money market schemes belongs to individual investors (retail and HNI). This Rs 60,000-66,000 crore is not a small amount.
Pankaj Pathak, fund manager, fixed income, Quantum AMC said: "This IL&FS incident should be seen along with many such instances in last few years, wherein credit rating downgrades or defaults in companies like Amtek Auto, Jindal Steel & Power (JSPL), Ballarpur Industries Ltd, etc, impacted debt mutual funds. What is more worrying is the repeated instances of liquid funds being impacted with these kinds of defaults. These events contradict the very nature and purpose of a liquid fund."
In defence of liquid funds
AMC officials are on the backfoot. Yet, truth be told, AMCs never saw the IL&FS credit downgrade coming. They say that all prudent norms were followed, due diligence was done, the IL&FS group brand and governance was given due weight. Commercial papers (CP) are an integral part of the portfolios of almost all liquid funds, which usually give 6-7% returns a year, but sometimes deliver 8% too.
G Pradeepkumar, CEO, Union AMC said: "IL&FS is major infrastructure player in India with assets spanning across surface transportation, energy, environment, education, construction with experience of over three decades. It is registered with Reserve Bank of India as a Systemically Important Non-Deposit Accepting Core Investment Company (CIC-ND-SI) and, hence, is regulated by RBI."
IL&FS is owned by reputed Indian and foreign institutions such as LIC (25.34% stake as on March 31, 2018), Orix (23.54%), Abu Dhabi Investment Authority (12.56%), HDFC (9.02%) and SBI (6.42%). The shareholders have regularly supported the group by way of capital infusion for growth. Currently, IL&FS Ltd's debt has been rated by three rating agencies namely ICRA, CARE and India Ratings.
"At the time of making the investment, IL&FS had AAA/A1+ rating from all the three rating agencies. Based on data shared with us, the company had adequate liquidity buffers and unutilised bank limits available to meet its short-term liabilities. The same was also confirmed through rating rationales released by rating agencies," Kumar said.
Rajesh Patwardhan, chief marketing officer, LIC MF explained that the IL&FS entities that were bought had A1+/P1+ rating and the fund-house had taken CP for three months. "Shareholders of IL&FS are the who's who. So, while investing, all parameters were taken into consideration. To update, LICMF Liquid Fund doesn't have any exposure to IL&FS Financial Services, whereas we have received maturity proceeds of Rs 200 crore from IL&FS Securities Services and the balance, which is less 2% of the portfolio of LICMF Liquid Fund will be received by third and fourth week of September."
Mirae Asset MF had told investors that in July 2018 it bought CPs of IL&FS Securities Services after the news of IndusInd Bank buying the firm was public. It relied on the credit quality of IndusInd Bank. Mirae has got the money back on September 10.
Who is responsible
The role of rating agencies has come to the fore prominently. But, fund managers ultimately choose the securities.
Vidya Bala, head of research at MF distributor Fundsindia feels the IL&FS incident is not a worry, and liquid funds remain true-to-label. As of July 2018, liquid funds on an average held 92% of their portfolios in A1+ papers (CDs/CPs).
"Other than Baroda Pioneer Liquid and Principal Cash Management none held A1 papers. Exposure to more volatile or higher credit risk papers was insignificant. IL&FS was an outlier case of a top-rated paper A1+ being downgraded to A4. This only raises questions about the credit rating agency's assessment of the paper."
Although the credit rating downgrade this time was pretty steep and swift, fund management teams of those invested liquid funds failed to exercise proper due diligence, said Manish Kothari, director & head of mutual funds, Paisabazaar.com. "Earlier in August this year, ICRA had downgraded the rating of IL&FS from AAA to AA+ on credit watch citing elevated debt levels, slow asset monetisation and deteriorating credit profile of its subsidiaries," he pointed out.
Fund managers have to stick to instruments with duration of fewer than 90 days and that essentially means they have to stick to low volatility papers. But low duration means limited options outside of treasury bills. Funds held about 11% on an average in treasury bills as of July 2018. "Only a small fund like Parag Parikh Liquid (Rs 130 crore) can hold almost four-fifths of its portfolio in treasury bills, as the amount to be deployed is small," says Bala.
Pathak says Quantum's liquid fund does not take any exposure in private sector corporations and invest only in government securities, treasury bills and highest quality instruments issued by PSUs.
If an investor is not lured by 'chart-toppers' in this category, there is very little to worry. Size of the AUM (at least Rs 1,000 crore) matters as any sudden exits can cause an impact on the NAV. There will be very rare occasions of mark-to-market losses in liquid funds but holding them for few weeks usually ensures the return of capital unless there is a default, Bala added.
SAFE INVESTMENT
Rs 6 lakh crore
Money in liquid/money market schemes
Rs 60,000-66,000 crore
Investment by individual investors in liquid funds
Rs 1,000 crore
Money invested by AMCs in IL&FS entities' securities
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