As the global economy goes into a tailspin and India’s growth rates nosedive, dirt from the mutual fund (MF) industry has been the first to hit the fan. On 23rd April, Franklin Templeton India Mutual Fund (FTIMF) announced
the winding up of six debt schemes that collectively managed over Rs27,000 crore. FTIMF will neither accept new money nor allow an exit to investors because it is unable to sell its illiquid investments to meet redemption demands. But FTIMF is not alone in spooking the market.
Under the benign eye of the regulator, who permitted the utterly fake industry slogan – Mutual Fund Sahi Hai (implying all MF schemes are absolutely safe), MFs garnered huge amounts of public money taking their total assets under management (AUM) to over Rs22 trillion by March 2020.
So now the industry calls the shots and is lobbying hard for a bailout by blaming all its problems on a virulent virus. COVID-19 provides the perfect excuse for everybody to wash their sins—a clueless government, failed regulators, reckless lenders, investment managers and corporate houses.
The MF industry aggressively demanded a bailout and the Reserve Bank of India (RBI) has already responded with a Rs50,000 crore ‘Special Liquidity Facility for Mutual Funds’ by way of a 90-day repo funding to banks to be used to extend liquidity to local MFs or purchase debt and commercial papers from them.
The scheme will be available from 27th April to 11th May, but the rating agency Fitch has already said that it will not serve the purpose as more ‘credit risk funds’ close their doors and go the Franklin way. But will the industry ever learn any lessons or keep blowing up public money every few years?
On 25th April, we wrote Neir Barote writes in The Mint
how BOI Axa Credit Risk Fund has suffered a vertical drop in net asset value (NAV) to the point that its returns, since launch, now stand at -17.86%. Its disastrous investments include IL&FS, DHFL, Sintex BAPL, etc. BOI Axa is a joint venture between Bank of India and the French insurer AXA, whose unique selling proposition was a tie-up with KKR India, an increasingly controversial
finance group for investment advice.
Some say that many shady schemes in the portfolio were acquired on its advice; but KKR is quick to wash its hands off. In an email to me, it says, “The advisory is limited and in the form of recommendations with respect to certain structured credit assets” and that it was not involved in “investing decisions, portfolio construction and management, portfolio and asset valuation, liquidity management.”
Those of us who had a ringside view to the ‘cowboy banking’ of the 1990s, which culminated in the massive securities scam of 1992, recall how every public sector bank (PSB) and insurance company, in cahoots with stock brokers and riding high on a booming market, subverted regulations. MFs took advantage of a regulatory vacuum and lured retail investors by promising ‘assured returns’ that were higher than bank term deposits.
These assured returns schemes were modelled after the mammoth Unit Trust of India (UTI) which eventually crashed and had to be bailed out by the government. Far from earning any returns, several MFs suffered capital losses and tried to renege on their commitment. A legal battle by Virendra Jain of Midas Touch Investors Association forced sponsoring banks and insurers, like Canara Bank, Bank of India, General Insurance Corporation, etc, to take the hit and pay up the returns assured by their asset management arm.
Debashis Basu’s book Face Value has a chapter on the reckless behaviour of government-owned MFs. BOI Mutual Fund has either forgotten history or learnt no lessons from the mid-1990s.
Mr Basu says, “Bank of India’s BoI Double Square Plus faced the biggest shortfall among the guaranteed return funds—over Rs800 crore” when an unequivocal promise to pay “4 times plus of the face value of each BOINANZA held” after 10 years. It initially claimed a relative small shortfall of Rs55 crore, which, after a central vigilance commission (CVC) investigation blew up into a Rs300-crore scam in the asset management company (AMC). This came to light only in 1998.
FTIMF’s problems too are less due to COVID-19 than the reckless bets of its high-profile fund manager. A big part of the problem was its exposure to debt of private, unlisted companies or promoter funding without a clear exit. It wrote off Rs2,000 crore exposure to Vodafone; it had an exposure to zero-coupon bonds issued by Wadhawan Global Capital, the personal holding company of promoters, as well as to Yes Captial, Rana Kapoor’s personal holding company. According to B&K Securities, it was the sole lender to 26 out of the 88 entities in its debt schemes’ portfolio. It also owned low-rated commercial paper from companies such as Vedanta Ltd, Clix Capital Services Ltd, Five Star Ltd, Indostar Capital and DLF, said the brokerage firm. What motivated such high risk-taking at investors’ cost?
History repeats in the financial markets every few years. Starting with the IL&FS failure in September 2018, there has been plenty of public information on the deep involvement of fund managers in scandalous investments in league with promoters of entities such as Zee/Essel, Anil Ambani companies, DHFL and Yes Bank founder Rana Kapoor’s private companies. Funds actively colluded to hide information about promoter lending from the stock market and had the temerity to announce a unilateral ‘standstill’ over sale of Zee group’s shares.
We have yet to see any significant action by SEBI (Securities and Exchange Board of India) to claw back bonuses of AMCs’ managers, disgorgement of fees earned on the basis of AUM or sacking of trustees, other than an occasional slap on the wrist. Moneylife has repeatedly written that nothing will change as long as MF fees are based on AUMs and not on performance; but the powerful industry lobby prevails.
Today, the MF industry is gigantic and there are no sponsoring banks to take the hit; so the buck stops with SEBI and RBI that need to focus on avoiding a more pervasive ‘systemic’ collapse.
Ajit Dayal, a veteran fund manager who ran among the cleanest AMCs (Quantum Asset Management), writes, “The mutual fund industry has become a veteran at seeking bailouts. First they create the mess, then they get into trouble, they put the entire financial system in jeopardy and then they stand in the bread line for a bailout!”And they have got it too.
In 2008, after the global financial crisis, while SEBI wanted to be firm, the then finance minister P Chidambaram was happy to offer a bailout through RBI without touching fees and bonuses. Ironically, he is at the forefront demanding a bailout for the industry again. The situation today is vastly different from 2008; then, India took pride in having escaped the global financial crisis, but only ended up postponing it, because the government and RBI opened credit lines to all and forgot to demand repayment causing bad loans to balloon.
This time around, we were already in the middle of a serious economic slowdown when the COVID-19 crisis hit us. MFs may lobby to dump all these dubious investments on to the central bank; but there isn’t enough money, even if RBI’s printing presses work overtime. The Centre and state governments have no funds and have bigger concerns like feeding the hungry who have been left without jobs or a livelihood by the lock-down.
Although a bailout may be inevitable from the larger systemic perspective, it will be scandalous if this is done without segregating dubious investments, forcing AMCs and their immensely well-paid fund managers to disgorge fees, stock options and bonuses collected over the past few years and, maybe, even cancel a few AMC licences after winding up their businesses.
Why can’t the precedent set by ICICI Bank in clawing back the salary and bonus paid to Chanda Kochhar be applied to dubious investment decisions by MFs? Prof JR Verma of IIM Ahmedabad, also a former regulator, has also offered a sort of ‘bail-in’ solution which requires the industry to participate in the rescue.
He writes in his blog:
“My preferred solution is for the mutual fund industry itself to create the buyer of last resort with only limited support from the sovereign. It is guided by the principle that whenever we bail out the financial sector we do so not to help the financiers but to protect the real economy which depends on a well functioning financial sector. In these troubled times, the real economy cannot afford the loss of any source of funding.”
This involves the creation of a special purpose vehicle (SPV) funded by the MF industry which will buy illiquid bonds. However, he suggests that the SPV has to be funded by investors, just like the controversial ‘bail-in’ for banks from depositors’ funds. If this includes retail investors whose money is blown up, there is bound to be a furore, but it may find acceptance if restricted to institutional investors.
The Yes Bank bailout could also offer a model worth considering. In that case, private banks stepped forward to participate in bailing out a private bank when it was clear that the loss could not be fully dumped on a public sector bank again and a systemic crisis needed to be averted. They stepped in even as global commentators and research firms were pushing for a public sector bailout.
Something similar should be demanded from MFs as well. Creating an SPV to hold viable illiquid shares is a sound idea; but the money probably ought to come from AMCs and from fees and bonuses disgorged from fund managers and trustees and not their investors. Especially in those AMCs which sold debt schemes like fixed-income securities or term deposits.
COVID-19 has created a massive economic problem at multiple levels—the powerful MF industry cannot be allowed a bailout without AMCs and fund managers putting their money in the basket.