What happened?:
JP Morgan India Short Term Fund and Treasury Fund have
fallen 3.38% and 1.73% respectively on
27 Aug 2015. Investors were set back by 3-6 months in their returns
Why this happened?:
The above two funds hold Amtek Auto security to the tune of
15.37% and 5.29% of the portfolio respectively as of end of previous month. The
stocks of the group in the equity market have been under pressure the entire month
- some falling more than 85% in value. The
rating agency, CARE has suspended rating on the company’s debt paper three
weeks back. Another rating agency, Brickwork has downgraded to C rating from A+. This necessitated the fund house to take a hit on the Rs 200
crore exposure to the tune of 25% – a loss of Rs 50 crores to the investors.
Incase of a default in the next coupon or principal payment, the hit taken by
the funds could be more.
Lessons to be learnt:
1.
There is no free lunch! The rationale for investing
in a fixed income product is for its very definition – “I want fixed income”. It is for the safety of the
principal and consistent stream of cash flows through interest payments all
through the time of investment.
2.
In the chase for returns, what might get
forgotten is that there is trade off between risk and return. The reason why a
company may pay a higher coupon / interest compared to the other is because of
the additional risk it carries – There is no free lunch in markets.
3.
Liquid funds may give negative returns and so do
debt funds, frequently! Through higher accrual (higher coupon payments), the
credit funds / part credit funds attract huge investor participation. Due to
higher payouts, the distributors also push them through. In 2008, a couple of
liquid funds has given negative return for the first time in the history of
Indian mutual fund industry. This was due to a liquidity event – the funds were
unable to sell the paper as the market was frozen. Other funds managed dip into
resources that bailed them out. The second instance was in 2013, on the fateful
day when RBI increased the short term rates by 300 bps, due to the interest
rate risk, the liquid funds across the industry gave negative returns. This was
a rude wake up call again that fixed income funds including liquid funds can
give negative returns. Infact for the next six months, funds across categories
gave negative returns. This episode was another occasion where investors and
distributors learnt the fixed income funds are also subject to volatility of
returns.
4.
Is there enough lunch on table? In India, the
exposure to credit funds does not offer the return which is commensurate with
the risk investors are taking – not much lunch left on the table. For instance,
10 year Gsec yields 8% today compared to about 10.5-11% by AA security. Post
the expense ratio, the realized yield is about 9-9.5% vs 7.5% in Gsec funds,
extra return of 1.5-2% for significant additional risk(funds hold varies
buckets of papers but just simplifying the explanation to make a point).
5.
The above does not indicate that one should not
enter credit funds. Investors should hope to get a kicker in the portfolio.
However, having a cap of 30-40% is a good idea. In a situation like today when
a fund takes a hit, one should be able to sail through the period for 6 months
to 1 year (and more probably) by tapping into other funds for liquidity and
income. Also, one should be aware that negative returns to the quantum quoted
above may be seen more frequently than in the past.
6.
Show what you are made of? It is very easy to be
on television and print media when things are easy. It is very difficult when
calls misfire. It is only during these times that the CEO and Fund Manager have
to be everywhere stating what steps are being taken. Investing is all about
predicting the future and taking calculated risks. In moments like these can
stakeholders understand better and become more mature for future. The CEO and
fund manager not being reachable to the people who recommended or invested in
their funds is a shame. These are the moments when it shows what you are made
of.
I am hoping that this is just a one off during
these tough times for various sectors before economy picks up steam. Being
discipline and diversified is the best formula to have sound sleep at night and
make money work
Disclosure: Views are personal. No exposure
to above mentioned funds.
