Mutual Funds
Rating Changes and Debt Mutual Funds
What are the lessons for investors and the regulator in debt mutual funds from the recent downgrades of Amtek Auto and Jindal Steel? 
 
Debt mutual fund investors focus mainly on returns and often ignore the risk. Over the past few months investors have woken up to the credit risk of mutual fund schemes. In August 2015, schemes of JP Morgan Mutual Fund suffered a sharp decline in their net asset value (NAV) as they had a high allocation to the debt paper of Amtek Auto. The credit rating of Amtek Auto was downgraded and soon investors begun withdrawing their assets from the scheme. In February 2016, debt investors faced a déjà vu. The credit rating of Jindal Steel and Power Ltd (JSPL) was downgraded and this affected the schemes of ICICI Prudential Mutual Fund and Franklin Templeton Mutual Fund. The NAVs reported sharp declines thanks to steep downgrades.
 
Downgrade of a credit rating is normal. Yes, it is sometimes a shock when the credit rating is notched down by three or four steps at one go. It essentially makes us think about whether the rating agencies were asleep? I can understand ratings getting ‘withdrawn’ because a company does not give information. Not giving information is something that an agency can ‘smell’, so long as it has a good surveillance mechanism in place. If they take monthly or quarterly information, they should be able to smell trouble the first time there is a problem.
 
CRISIL recently downgraded JSPL from BBB+ to BB+. This is a three-notch downgrade. The hierarchy is BBB+, BBB, BBB- and then BB+. The divide between BBB and BB is huge. Debt papers up to BBB- are considered ‘investment’ grade and anything below is considered ‘speculative’ or ‘junk’ grade. A move from BBB to the BB is not an unusual one, given the sector the company operates in and its leverage. What I question is the wisdom of the reputed fund houses in taking such huge exposures on something that was already a borderline investment grade. If you are a hedge fund or a speculative investor, such high yield papers are fodder for you. But mutual funds have to be more careful.
 
CRISIL says that the earlier rating of BBB+ had factored in the sale of a unit in Bolivia and the receipt of the proceeds before March 31, 2016. They have not waited for the date, but have fairly concluded that it is not happening and pulled the trigger. In a sense, we can debate whether the earlier rating should have anticipated this inflow and if it was such a crucial thing, could the rating have been BBB minus? Not being privy to all the facts that they would have had, I respect their view. I have been part of the organisation nearly 22 years ago and still trust the checks and balances in place. What I can say from my knowledge is that when I buy a ‘BBB’ paper, my risk of losing money is very high. And let me tell you, no rating agency is immune to a structured fraud. 
 
I differ with rating agencies on one aspect of rating - “Structured Debt”. At the time I was working in the agency, I was at the forefront of developing it. However, over time I see more and more complex structures that a rating cannot really bind together. But commercial interests prevail. Securitisation is merely a paper exercise of ‘selling’. In reality, if an originator of loan sells the loan to an investor or a trust, I do not see how they can really collect on it. 
 
The rating agencies have the power to downgrade, suspend or withdraw a rating. If there is high quality surveillance, I do not see a reason for an abrupt downgrade by two or three notches, unless it is the result of a corporate action, where there is some merger or acquisition or the company has suppressed some facts, which came to light later on. Not giving information as agreed is a serious issue and should lead to rating getting withdrawn.
 
The recent downgrades of a couple of papers, its impact on the mutual funds that invested in those have been the subject of an acrimonious debate. Here I blame the agencies as well as the fund houses. Fund houses should be using the rating as an additional input and not as a primary input. They should be having the skills to evaluate credit. Yes, a rated paper can help you to find companies you have to shortlist. Beyond that, there has to be an internal analysis that approves the paper. Often, the analysis is cursory and we do not see a single ‘debt’ research report. Hopefully, the analysts read the “rating rationale” that accompanies every rating.
 
The impact of the downgrade on a paper is dependent on the extent of exposure a scheme has, to such paper. A 3% exposure of a scheme in to the paper of JSPL, impacted the NAV of the scheme by nearly half a percent. In a sense, if an income scheme has a carrying yield of 7%, nearly 14 days of interest accruals on the entire scheme has gone! And the mark to market to junk, would mean that the fund is unlikely to fetch the marked price in any sale, as no one would immediately buy the paper. So, the actual impact could be higher! 
 
When MFs are handling retail money, in an environment that is thriving on mis-selling, we need to see some reforms in the industry. Maybe the regulators could consider:
 
 i) Allow retail money to be invested only in those schemes where no paper has a rating lower than AA. Not even AA minus, at the point of inception. There should be a clear mandate that if any paper is downgraded, it should be offloaded within 15 days. That would minimise the retail risk somewhat;
 
ii) Schemes that have lower rated papers, should be RED labelled and the minimum investment amount could be hiked to Rs50 lakh kind of threshold. That implies that those with this kind of surplus understand risks better. 
 
iii) Multiplicity of rating agencies has been an issue. Regulations say that ratings from any ‘recognised’ rating agency is acceptable. Unfortunately, the quality of the rating agencies differs. I will not name the culprits, but every debt fund manager knows about it. Maybe the trustees can insist on two ratings as a minimum requirement. Even in the debt market, companies with the same rating do not enjoy the same pricing. Markets do make a distinction.
Valuation of debt papers is always a contentious issue. Some papers cannot be traded unless offered at a discount to comparable paper. 
 
The retail investors, coming into debt mutual funds, come in for capital protection as well as a perceived tax advantage. Many of the small investors who put in a few thousands, are outside the tax bracket. These are the investors who need regulators to offer protection. We have seen how miserably the regulators have failed when it comes to insurance company products. Will mutual funds also go the same way? 
 
There are some folks who say that so long as everything is ‘disclosed’ in the offer document, the investor should not mind. I have yet to meet any average investor who is even aware what such a document contains. At the time of NFO, a four pager is all that is sometimes given. Of course, everything is ‘available’ online. Why cannot SEBI design a simple one pager that goes with every scheme- on the web page, on the application form and with the account statement? I will be glad to help design it.

User

COMMENTS

Ramesh Poapt

9 months ago

ML-discussion on the topic proceeded nicely. You have knowledgeable readers. Good one indeed!Request more such goood articles!

Avinash

9 months ago

Agree with most of points made in the article. However, instead of placing restrictions on retail participation in debt markets, which would hurt the efforts of broadbasing capital markets, I have a few suggestions:

1. Credit funds which invest in papers rated lower than an acceptable benchmark (say, AA) should be demarcated with a separate risk rating
2. Risk-Return indicators like Sharpe ratio, sortino ratio and standard deviation (ofcourse, in a language that a novice would understand) must be mentioned for (a) the scheme, (b) aggregate of similar schemes of the fund house, (c) category average across industry. A legend should accompany this disclosure to help investors interpret the numbers
3. An abridged version of the Mutual Funds SID must accompany all application forms (if physical) and should be displayed prior to concluding the transaction (if electronic). This one-page document must at-the-least contain the risk rating, risk-return indicators, Fund manager, benchmark index etc.
4. Efforts on curbing mis-selling must continue unabashed.

Fixing responsibility on rating agencies and ensuring their 'skin-in-the-game' needs to be handled separately as ratings are used by institutional investors and retail investors alike.

Gupta

9 months ago

After the Amtek fiasco, CRISIL proudly released a press release with nice looking statistics that none of its investment grade rating (BBB- or better) has been downgraded by more than 1 notch and hence the quality and stability of CRISIL ratings is much better than others. While I don't disagree with that claim (on a relative basis given the weaker quality of other rating agencies and not because CRISIL is a holy cow), CRISIL may have wanted to be more circumspect. JSPL is a much larger company with much larger debt and should have had stronger surveillance. CRISIL has been found sleeping at the wheel (or with JSPL because JSPL pays for the rating) with this 3 notch downgrade. Any banker or MF fund manager who understand JSPL can say that Bolivia was an irrelevant chapter in JSPL's history and certainly can't be the reason for even a 1 notch downgrade, forget 3. CRISIL is simply hiding behind it to cover up for being cosy with its "customer" for too long. It is once again proven that rating agencies always downgrade after the event and predictive ability of credit ratings is ZERO. While stock prices have nothing to do with credit ratings, they are far better tools to predict what is going on with the "credit". The conflict of interest between borrowers and rating agencies is deep and since rating agencies only give opinions and don't have to lend on their own ratings, the problem will never be solved. Worth considering if RBI would mandate rating agencies to invest their rating fee in the debt of the issuer for a period of 12 months and if there is a downgrade of more than 1 notch, then pay a penalty of 10 times that fee to a consumer protection fund. Radical thought it may be, but we need something to resolve the conflict of interest. RBI did something very similar with Asset Reconstruction Companies few years ago by banning 100% SR buyouts and forcing a cash component.

REPLY

R Balakrishnan

In Reply to Gupta 9 months ago

Fully agree. Name recognition seems to have played a bigger role..

Nilesh KAMERKAR

9 months ago

Those who cannot stomach few basis points of volatility, for them mutual funds is not the place to be. For absolute Capital protection there are Bank Fixed Deposits.

Selling debt paper within 15 days of it being downgraded is a sure way of losing capital.

Even with the most noble intentions some debt papers will still deteriorate in quality. In this deterioration lies risk as well as opportunity.


REPLY

R Balakrishnan

In Reply to Nilesh KAMERKAR 9 months ago

The only solution, Nilesh, is to forget the NAV impact and hold to maturity? That would be a cross subsidisation and lead to gaming by big punters

Nilesh KAMERKAR

In Reply to R Balakrishnan 9 months ago

Dear Sir,

Please do consider the foll:

1) The scope for gaming the system shall be far higher if funds are forced to liquidate debt instruments within 15 days of being downgraded, resulting in substantial losses as not much can be salvaged in such situations.

2)Sir you shall agree when investors jump the scheme immediately after NAV is impacted, they turn notional losses into real losses.

3)Investors would do themselves a great favour if they wait to exit, till such time that their returns from the income fund is say 1% better than FD rates, then purpose of investing in debt mf would have been served .

4)For 3 above to happen investors ought to worry about NAV linked returns rather than scrutinize the portfolio. - That is best left to the professional fund manager

5) Debt downgrades and defaults have happened in the past too. And investors in open ended debt funds,(& not FMPs) who chose to continue have come out unscathed with reasonable returns to boot.

R Balakrishnan

In Reply to Nilesh KAMERKAR 9 months ago

You are right, Nilesh. But you underestimate the idiots in the world. logically, I do not see the need for this instrument to exist at all. Equities and liquid funds good enough for me. Maybe a savings account . Bond funds is for those who build a bridge to nowhere.

R Balakrishnan

In Reply to Nilesh KAMERKAR 9 months ago

Any downgrade will have a loss of capital. Whether u sell it today or after one year. Problem is if we have a discipline or a rule book, we should play by it, when retail money is involved. Retail who come in from the FD markets

R Balakrishnan

In Reply to Nilesh KAMERKAR 9 months ago

Yes, Nilesh. You understand. I too understand. A few out there who do not. Bulk of investors are like that.

Security Matters

Nobody can protect you from fraudsters, if you are not careful and give away personal details easily

 
Many are (still) under the impression that once you install a software or an app, it will take care of your device’s safety and security. To add to this, advertisements from a few anti-virus software companies are doing the rounds with claims to give you ‘peace of mind’ while doing online financial transactions. But this is just one side of the bigger, and complex, security issue. No doubt, there are some good software products which can help you remain safe from attacks of hackers or viruses or malware. However, they have their own limitations. No software or mobile app can protect you if you decide to bypass their security rings and visit (or click) an unknown URL or link. The same holds true when you download and install mobile apps from anywhere other than the official play stores. Even when you download ‘free’ apps from official sites, be mindful of how much information that app will ‘steal’ from your mobile device. Remember there are apps, like for battery-saving or mobile-boosting, that are more interested in reading your contact details or call logs. No software or apps developer will accept it; but your data and personal information is out there for exploitation or sale at a price, if you do not follow certain rules.
 
So, first, make yourself ‘fool’-proof by not revealing mobile numbers, credit or debit card number and its security code or any other personal detail related with your financials, especially over phone calls from beautiful voices. Remember, no regulator, like the Reserve Bank of India (RBI) or the Insurance Regulatory and Development Authority of India (IRDAI), or even your bank, has the time to call individuals seeking personal data. Banks already have them and will never ask for it from the customer. 
 
If you are a smartphone user, you can use mobile apps like TrueCaller to identify the caller and also block spam calls automatically. I know, such apps would get access to your phone data and may use it, but it also help you to identify a spam caller.
 
Secondly, never ever click on any unfamiliar link received either through social media or chat programs or via email. Even if the link appears familiar, visit the original website and go to the linked page from there. 
 
This brings us to our next point about web security. Do check the encryption level of the URL which you may be accessing, especially for financial transactions. There should be an additional ‘s’ in the address bar, like https. Also check for the lock icon in the address bar. This denotes the security level and should display the website’s security certificate after clicking on the lock icon. 
 
Fourth, never, ever, share your mobile number or email ID in public forums. Funnily, there are people who believe in sharing entire email conversations, including email IDs, contact numbers in the comments on Moneylife’s website, and that too on articles that warn people about the same fraud. In one article, we wrote about how fraudsters are luring people under the pretext of offering lottery money in the name of RBI. However, despite the red flag, there are several people who keep posting the entire message received from such fraudsters. One reader has even posted an ‘affidavit’ and his bank details so that he can receive the lottery money from the scamsters! 
 
Many also write their ‘secret’ code or PIN on a piece of paper and keep it next to the credit or debit card. Some smart people even write it on the reverse of the card. Forget about software or mobile apps, even the God cannot protect such people! You should create passwords and codes or PINs that are hard to guess but easy to remember (only for you). 
 
So the next time you receive a call from a ‘beautiful voice’, ask the caller to send the request in writing, without revealing any of your personal details, including email ID or your address and disconnect the call. Also, do not forget to mark it as spam-caller or put it in your call/SMS blacklist. 

User

COMMENTS

Simple Indian

9 months ago

Good tips in general, though many people are already aware of them yet give them a miss, for their convenience. The last para was intriguing though. How does one ask the caller to give it in "writing" without giving one's email / address ?
I believe even apps like Truecaller do collect personal information of the mobile user, including the call log, messages, surfing info, etc. which it shouldn't. Hence, don't install any such App, and instead opt for paid tried-n-tested security Apps like XYZ Mobile Security - after reading the user reviews of the App. Also, one can check the user ratings of the App in the Google Play Store (or corresponding place for iPhone & Windows Phone OS users).
Finally, no matter what steps one takes to secure one's info, what gets them drawn into scams is their greed. There's no App to control human greed, yet.

manoharlalsharma

9 months ago

u r not aware that this country is master in litigation business as POLITICS involve,have u know how difficult to protect u r RESIDENTIAL flat from the Co-Operative housing society? How a Greedy committee to eat away the earning from redevelopment premium and how to restraint u r entry to EGM./GM meetings, through HC stay if u want a real/live story Go to WP-8508/2003 and learn how to get FINAL order STAY?

A Cancer-free World

Urgent research is needed to get to know more foods containing Laetril (vitamin B17), to help control and cure cancer

 
Edward Griffin, in his celebrated book World without Cancer, gives us a bird’s eye view of the cancer drama in our conventional medical worldview. I am happy that many of my long-held views in this area have been reaffirmed. Of course, the consensus view in our conventional medical world might not agree at all. Let us, for a minute, think that if they were to agree, the whole cancer world will collapse and, with that, the trillions of dollars’ worth of business! 
 
One sentence in an earlier book, Science of Medicine and the Quiet Art, by David Weatherall, a great cancer researcher and a Regius Professor of Medicine in Oxford who was my beacon in this area for a long time, to which Griffins has added sumptuously indeed! David writes something like this. (These are not his exact words). ‘Our present cancer therapy reminds me of our ancestors treating every single disease with red-hot iron. Today, we burn our patients with radiation; poison them with chemicals; and mutilate them with surgery. I am sure, our future generation will never forgive us for this inhuman torture.’  
 
The history of cancer is a history of the greed of the healthcare business. An independent survey, recently, showed that conventional treatment results are: cure rate in advanced cancer is just 0.1/10%; milder disease 18% and, in very early and not-so-aggressive cancers, 20%. Griffin shows methods of treatment and prevention which can give us 100% results.
 
I was listening to an agricultural scientist of great repute in the US, Dr Khader, who has transformed himself into a healer through food-as-medicine, near Mysore. He has shown that millets can cure almost every conceivable disease including cancer. Moreover, they could prevent cancers. Coming back to Griffin’s book, it says that Laetrile (vitamin B17) prevents cancer 100% and treats the same in large doses even after cancer manifests in those who have not prevented it. Millets contain lots of Laetrile; many other fruits and nuts also contain it. 
 
Dr Khader might have hit the jackpot accidentally. We should take this work seriously and go forward to confirm its claims, for the good of mankind. History is replete with stories of men, who brought in new ideas into medicine, being persecuted during their lifetime by the conventional medical bigwigs of their time. Their work got recognition and mankind benefited long after they were hounded 
out.
 
Beriberi was treated as an infection and treated with arsenic for hundreds of years, even though reports of Beriberi being a nutritional deficiency were long known. Scurvy killed thousands of British soldiers on the seas in the years when even the native Americans knew that it was due to fresh fruit deficiency! SMON (sub-acute myelo-optico-neuropathy) killed so many when it was thought by the establishment to be due to a slow virus like Kuru. In fact, it was due to an adverse drug reaction to Quinolones used to control tropical diarrhoea. Even though great researchers have found no connection between HIV virus and AIDS syndrome, millions are getting the wrong treatment even today. 
 
Now, slowly, people are realising that there is no disease called ‘high cholesterol’; but we have damaged millions with dangerous cholesterol-lowering agents. When we know that the human mind is not in the human brain, we still use powerful brain-altering drugs to treat mental illnesses like depression. The story is there for all of us to know. Cancer is no exception.
 
Urgent research is needed to get to know more foods containing Laetril to help mankind and also to convince our colleagues in the conventional medical world to see the logic and come to their help. If everyone puts his/her head together to help cancer patients and shed our biases, mankind will be grateful and our future generations will appreciate our good work.

User

COMMENTS

Venkatesh Yeddula

5 months ago

Dr B M Hegde,It is indeed a nice write up.Is cancer really preventable.I think you know how a normal cell transforms into cancer.Age itself is the biggest risk factor,because with increasing age,the constant impact of the insults suffered by our body and its cells,with waning of the immune system,and also the DNA repair mechanisms becoming slow or inefficient,cancer is one of the nature's mechanisms of annihilating an individual to death.
Fresh fruits,vegetables,good exercise,good sleep, calm mind all bring about the well being of the individual.However,in spite of all these we all still die.By following good diet,exercise etc we may live healthy till old age,but there is some mechanism to die.
Now,u must know that post mortem studies of aborted foetuses and dead infants ,during the 70s had shown that there are fatty streaks over which atheromatous plaques develop in later life,and ultimately the blood vessels to the heart or brain get blocked when we are old enough to die,and this is the cause of natural death in over 90 percent of the dying population.Smoking,alcohol,sedentary lifestyle,genes,diabetes mellitus,hypertension,type A personality all add up to kill a person early by accelerating the natural process of atheromatous blockade of blood vessels,esp to brain and heart,resulting in MI and strokes.
Now regarding vitB17 Or Laetril has inhibitory properties on the cell transformation through various yet to be elucidated mechanisms,we have vit A,vit C,antioxidants, which have been proven to be effective in preventing cancers for a fairly long periods of our lives.Smoked salmon causing cancer,is one of the early carcinogens to have been identified.Similarly we have red meat diets causing colon cancers,and mango and papaya preventing the colon cancer for fairly long periods of our lives.

Regards to cholesterol lobby,coronary stunting lobby etc,I think u agree that these were started by the medical fraternity with the noble idea of healing patients,not knowing long term outcomes,at the outset.Science will accept defeat and these will be abandoned once newer ( or older) better methods are made available to treat these diseases.
If Dr Khader is treating patients with millets,it's great.But should we not take up a good study ,a randomised controlled study to prove or disprove its efficacy and claims ,by the millet lobby.
I don't agree with your cholesterol tirade completely.There is a volume of research to show that HDL :LDL ratio is having a fairly good correlation to causation of acceleration of atherosclerosis(as I told u atherosclerosis is a natural aging process).Nobody had an express idea of making money over cholesterol reducing drugs.
Though later it was found that homocysteine too is a culprit in accelerating atherosclerosis,and B complex vitamins can reduce this speed of progression of atherosclerosis.

REPLY

Narayan Panje

In Reply to Venkatesh Yeddula 5 months ago

Where does Dr BM Hegde said in his article one will not die ! Everybody knows death is certain, the thing is ' How to remain healthy till death?'. Dr BM Hegde's article is educative.

Ramesh Poapt

9 months ago

Excellent! Dr.Hegde,pl. extend on Vit.B17/millets for cancer!

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