I have a strong piece on the current controversy on fund managers' investments into the Zee promoter group companies in today's Economic Times. Three things require closer scrutiny. a) Better disclosure by fund managers b) policy relook at lending against shares to promoters and c) cute structures bypassing the 10% exposure limits to one corporate entity (concentration norms). Most importantly, fund managers need to be humble and not aggressive. If they cant feel for the investors, maybe its time to use some glycerine.
‘Mutual fund sahi hai’ and ‘mutual fund products are subject to market risks’ are both important messages to investors. Both are points of highlight this week. The ‘sahi hai’ has become the butt of a joke on Twitter while fund managers have been at pains to aggressively assert that the products were “always risky”.
As a lawyer, I decided to do a deeper dive into the offer documents of a few of the fixed maturity plans, or FMPs, to unravel the story in a bit more depth.
The context in brief is that several FMPs which were maturing this week had exposure to debt instruments of the Zee promoter group. In January this year, several mutual funds came to an understanding with the promoter companies —the borrowers — that they would not insist on a timely payment in order to give the borrowers time to unwind assets and pay the mutual funds fully.
The private limited companies of promoters had borrowed money from mutual funds based on the collateral of the listed securities of Zee, and if all mutual funds had sold along with other lenders, the price of the stock would have fallen and the security cover would likely have become inadequate. While many have criticised the arrangement, calling it a sweetheart deal similar to ‘evergreening’ of loans by banks, the criticism is unfair. Fund managers have taken a good faith call that they are more likely to get the money if they forbear for a few months and it would be wrong to cynically second-guess them.
However, there are many important policy questions which need to be tackled. The FMPs reviewed could invest in ‘listed or unlisted, secured or unsecured, rated’ securities. It’s also stated in the scheme document: ‘the Scheme is expected to maintain a high quality portfolio and manage credit risk well. Investments may be made in instruments, which, in the opinion of the fund manager, are of an acceptable credit risk and chance of default is minimum’. Finally, the schemes are restricted from investing more than 10% of their assets issued by a single issuer and the total exposure in a group cannot not exceed 20% of the assets of a scheme.
The problem lies with the instruments. While funds cannot directly lend to promoters against collateral of shares, if the promoters set up corporate entities which issue bonds with the collateral of shares of the listed company, that would be permissible. This is legal, but debatable from a policy perspective, as to whether mutual funds should be in loan against shares market, rather than lending to corporate India. Additionally, in senseless chasing of yields, some mutual funds have scraped the bottom of the barrel trying to get that extra half percentage of yield, but taking on huge risk along the way. The liquidity risk, as we are learning as investors, is somewhat binary – liquidity evaporates not on a slide, but in a flash. When crisis hits, you cannot sell corporate bonds at any price.
The second problem which is apparent from the restriction on single borrower limits set at10% is that some of the funds have acted cute. While no scheme can invest more than 10% with a single issuer, there is technically no bar to lending, say 30%, to three promoter entities against shares of a single listed entity. This needs to be addressed and Sebi needs to clearly state that the 10% limit cannot be breached by creating multiple holding companies to bypass the limit. The point of the limit is to contain concentration risk in a single entity.
Finally, the quality of disclosures and general messaging by mutual funds has been poor. There had to be a very clear articulation by the funds as to the negotiation, why they believe the deferral was in the best interest of the investors and also a very clear articulation on the date of the maturity of the FMPs as to why they are deferring part of the payment, stated with clarity and with humility. The television appearances by fund managers stating it’s a risky product could not have been worse-timed.
Here is a hint to fund managers, leave the defending of your actions to lawyers, when you speak in public media, be humble and shed a tear for your investors, even if you need to use glycerine. To be sure, there is still a lot of pain ahead for investors, and cute structures are going to be scrutinised closely by the regulator. Funds need to be not only true to fine print, true to label but also true to their fiduciary duty. Beyond that investors must assume the market risks and know that they are not investing in fixed deposits, and be aware that risk and returns go hand in hand.
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