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Why Your Money In Liquid Funds Is At Risk - Outside View by PersonalFN

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Why Your Money In Liquid Funds Is At Risk
Oct 3, 2018

Every time you are aboard a flight, the flight attendants brief you on the pre-flight safety instructions before take-off. Flight attendants perform a live demonstration in the aisle, while another attendant relays the instructions over the public address system.

The highlight of these instructions, safety first, is a principle we all follow in our day-to-day life. Right from wearing a seatbelt while driving a car to flying in an aircraft, or switching the regulator of the gas cylinder off before one goes to sleep.

So why is it that when it comes to money many of us become careless?

Pertinently, what if such carelessness is demonstrated by professionals who are hired to manage your money, along with an element of safety?

The recent IL&FS episode is another example of the carelessness fund managers deploy when they put the safety of investor's money at stake.

Well I am not talking about debt mutual funds here, as they are risky in nature.

But, what about liquid funds? Aren't they meant to be safe in the first place and offer liquidity to investors?

Liquid funds are supposed to be an ideal alternative to one's savings bank account. That's the reason their primary objective is to keep your money safe and offer daily liquidity.

Remember, returns come secondary. But many fund managers seem to be neglecting the rule and aim for a higher yield on liquid funds instead. Primarily, it's a race to attract more investors with the higher returns on liquid funds.

Obviously, more AUM means more money and revenue to the asset management company, which takes care of the salaries and incentives of their CEO's and fund managers too.

When mutual fund managers fail to do their homework and end up investing in debt securities issued by unreliable companies, thousands of investors suffer.

Recently, the Net Asset Values (NAVs) of several liquid and debt funds took a hit in the range of 0.5% to 8%. The losses these incurred were effectively within a span of few days. Few liquid funds had to mark down their investments in Infrastructure Leasing & Financial Services (IL&FS) and its group companies owing to sudden credit rating downgrades.

Notably, debt securities issued by IL&FS and its group companies were rated top notch by top rating agencies like ICRA and CARE until last month. On September 10, 2018, ICRA downgraded non-convertible debentures of IL&FS Financial Services to 'BB' from 'AA+'. It also downgraded the short-term commercial paper of the company to 'A4' from 'A1+'.

Securities issued by its other group companies too have been further downgraded to below investment grade. The downgrades follow the companies defaulting on interest payments on their bonds.

Table 1: To what extent are the liquid and debt funds relying on the unreliable IL&FS

Scheme Name Category Asset Type Company Name Rating as of Aug 2018 Value (Rs in Cr.) % of Assets
Aditya Birla SL Credit Risk Fund Credit Risk Funds Corporate Debt IL&FS Education & Technology Services Ltd. AA-(SO) 19.67 0.24
IL&FS Tamil Nadu Power Company Ltd. A+(SO) 170.02 2.04
Aditya Birla SL Medium Term Plan Medium duration Funds Corporate Debt IL&FS Education & Technology Services Ltd. AA-(SO) 110.80 0.97
IL&FS Tamil Nadu Power Company Ltd. A+(SO) 237.54 2.07
BOI AXA Credit Risk Fund Credit Risk Funds Commercial Paper Infrastructure Leasing & Financial Services Ltd. A1+ 103.60 6.13
DSP Bond Fund Medium duration Funds Corporate Debt IL&FS Transportation Networks Ltd. AA+(SO) 12.52 1.89
DSP Credit Risk Fund Credit Risk Funds Corporate Debt IL&FS Energy Development Co. Ltd. A+ 224.29 3.26
IL&FS Transportation Networks Ltd. AA+(SO) 220.92 3.21
DSP Ultra Short Fund Ultra Short Duration Funds Corporate Debt IL&FS Transportation Networks Ltd. AA+(SO) 62.58 1.48
HSBC Cash Fund Liquid Funds Commercial Paper IL&FS Financial Services Ltd. A1+ 104.91 1.40
Invesco India Credit Risk Fund Credit Risk Funds Corporate Debt IL&FS Transportation Networks Ltd. AA+(SO) 31.18 7.73
LIC MF Liquid Liquid Funds Commercial Paper IL&FS Financial Services Ltd. A1+ 199.20 1.20
IL&FS Securities Services Ltd. A1+ 497.68 2.99
Mirae Asset Cash Management Liquid Funds Commercial Paper IL&FS Securities Services Ltd. A1+ 49.89 2.00
Motilal Oswal Ultra Short Term Fund Ultra Short Duration Funds Commercial Paper Infrastructure Leasing & Financial Services Ltd. A1+ 98.24 9.87
Principal Cash Management Fund Liquid Funds Commercial Paper IL&FS Financial Services Ltd. A1+ 102.08 9.81
Principal Low Duration Fund Low Duration Funds Commercial Paper IL&FS Financial Services Ltd. A1+ 2.98 0.57
Principal Ultra Short Term Fund Ultra Short Duration Funds Commercial Paper IL&FS Financial Services Ltd. A1+ 8.96 7.59
Tata Corp Bond Fund Corporate Bond Funds Corporate Debt IL&FS Financial Services Ltd. AA+ 24.68 4.60
Tata Money Market Fund Money Market Funds Commercial Paper Infrastructure Leasing & Financial Services A1+ 49.33 2.33
Tata ST Bond Fund Short Duration Funds Commercial Paper Infrastructure Leasing & Financial Services Ltd. A1+ 166.94 3.17
Union Liquid Fund Liquid Funds Commercial Paper IL&FS Securities Services Ltd. A1+ 49.61 1.99
Infrastructure Leasing & Financial Services Ltd. A1+ 49.84 2.00
Portfolio holdings as of August 31, 2018
(Source: ACEMF)

As seen in table 1, about 18 open-ended debt mutual fund schemes collectively had an exposure of about Rs 2,600 crore into bond instruments issued by IL&FS and its group companies, as on August 31, 2018. Of these...

  • Liquid funds held an exposure of around Rs 1,053.2 crore
  • Credit Risk Funds held Rs 769.7 crore
  • Medium Duration Funds held Rs 360.9 crore
  • Ultra Short Duration Funds had about Rs 169.8 crore
  • Short Duration Funds held Rs 166.9 crore
  • Corporate Bond Funds had an exposure of Rs 24.7 crore
  • Money Market Funds held Rs 49.3 crore, and
  • Low Duration Funds carried instruments worth Rs 3 crore, in their portfolio.

Each of the 18 schemes easily held about 1.5% to as much as 10% weightage to debt instruments issued by IL&FS group. While LIC Mutual Fund, Aditya Birla SL Mutual Fund, and DSP Mutual Fund were the major holders of the IL&FS group securities, it was Principal and Motilal Oswal Mutual Fund that were severely impacted. The liquid and ultra-short duration funds such as Principal Cash Management Fund, Principal Ultra-Short Term Debt Fund and Motilal Oswal Ultra Short Term Fund had about 8%-10% of their assets in instruments of IL&FS group companies.

Few other schemes like Invesco India Credit Risk Fund (7.73%), BOI AXA Credit Risk Fund (6.13%), Tata Corp Bond Fund (4.6%), LICMF Liquid (4.19%), DSP Credit Risk Fund (6.47%), Aditya Birla SL Credit Risk Fund (2.28%), Union Liquid Fund (3.99%), Tata ST Bond Fund (3.17%), and Aditya Birla SL Medium Term Plan (3.04%) carried significant weightage in securities issued by IL&FS group companies.

Now here's something to consider...

What would happen to one's investment if the fund were to write-off such a large exposure to these instruments?

Table 2: IL&FS is bleeding and so are liquid and debt funds

Scheme Name Category Month Till Date 1 Day Change in NAV on 10/Sep/18 1 Day Change in NAV on 17/Sep/18 1 Day Change in NAV on 24/Sep/18 1 Year
HSBC Cash Fund Liquid 0.50 0.02 0.02 0.02 7.12
LIC MF Liquid Liquid 0.49 0.02 0.02 0.02 7.04
Mirae Asset Cash Management Liquid 0.50 0.02 0.02 0.02 7.07
Principal Cash Management Fund Liquid -7.95 -1.21 -1.60 -5.72 -1.85
Union Liquid Fund Liquid -2.92 0.02 0.02 0.02 3.41
DSP Ultra Short Fund Ultra Short Duration -0.53 -0.35 -0.35 0.01 5.33
Motilal Oswal Ultra Short Term Fund Ultra Short Duration -6.12 -1.86 0.05 -0.01 -0.94
Principal Ultra Short Term Fund Ultra Short Duration -5.24 -1.00 -1.01 -3.45 0.54
Principal Low Duration Fund Low Duration -0.75 -0.14 -0.11 -0.37 5.35
Tata Money Market Fund Money Market -1.33 -0.55 0.06 0.04 5.36
Tata ST Bond Fund Short Duration -2.91 -0.90 0.02 -0.15 0.88
Tata Corp Bond Fund Corporate Bond -2.53 -1.20 0.00 -0.09 2.68
Aditya Birla SL Credit Risk Fund Credit Risk Fund -0.60 -0.21 -0.02 -0.09 4.85
BOI AXA Credit Risk Fund Credit Risk Fund -1.90 -0.11 -1.48 -0.14 5.00
DSP Credit Risk Fund Credit Risk Fund -2.77 -0.94 -0.82 -0.10 1.33
Invesco India Credit Risk Fund Credit Risk Fund -2.33 -0.86 -1.16 -0.08 2.43
Aditya Birla SL Medium Term Plan Medium Duration -0.81 -0.26 0.02 -0.14 3.94
DSP Bond Fund Medium Duration -1.31 -0.60 -0.44 -0.13 2.56
Month Till Date and 1 Year performance calculated as on September 26, 2018
(Source: ACEMF)

Any write-off in the value of a security that liquid and debt mutual funds hold can lead to a negative return. That's the reason most of the schemes holding exposure to IL&FS group companies are currently bleeding red.

The NAV of Principal Cash Management Fund, Motilal Oswal Ultra-Short Term Fund, and Principal Ultra Short Term Fund are down 7.95%, 6.12%, and 5.24% respectively, this month.

Other schemes like Union Liquid Fund (-2.92%), DSP Credit Risk Fund (-2.77%), Invesco India Credit Risk Fund (-2.33%), Tata ST Bond Fund (2.91%), Tata Corp Bond Fund (-2.53%), BOI AXA Credit Risk Fund (-1.9%), Tata Money Market Fund (-1.33), and DSP Bond Fund (-1.31%) are down more than 1% this month.

Do fund managers really care about the interest of investors?

I wonder if fund managers really learn from their past mistakes. Well, this is not the first time that mutual fund managers have taken thoughtless investment decisions and relied solely on the ratings provided by rating agencies.

Isn't it the duty of the fund management to follow an internal risk assessment process and proper due diligence before committing money to such risky securities?

Earlier too, mutual funds have lost investor money in entities like Amtek Auto and Jindal Steel & Power Ltd (JSPL).

In September 2015, Amtek Auto had defaulted on the Rs 800 crore worth of bonds, which adversely impacted JPMorgan Mutual Fund. In fact, it had to even restrict withdrawals from two of its funds because of the Amtek bond ownership. The fund house later sold the Amtek Auto papers to a private equity firm at a 15% loss.

Similarly, Jindal Steel & Power Ltd (JSPL) too had defaulted on interest repayments to its bonds holders, due in September 2016. Franklin Templeton Mutual Fund, the biggest holder of the company's bonds had to dump its holdings worth Rs 1,000 crore in JSPL at a steeper discount. ICICI Prudential Mutual Fund was the second-highest holder of JSPL bonds worth almost Rs 500 crore.

Is your money in liquid funds really safe?

To answer this, let's take a look at the type of instruments held by liquid funds.

Table 3: Should liquid funds still bet on corporates?

Instrument Type Corpus (Rs in Cr.) % of Total Liquid Fund Corpus
Commercial Paper 393,088 68.89
Certificate of Deposit 64,566 11.32
Treasury Bills 57,125 10.01
Deposits 22,182 3.89
Cash & Cash Equivalents and Net Assets 16,703 2.93
Corporate Debt 10,854 1.90
Bills Rediscounting 2,537 0.44
Cash Management Bill 1,784 0.31
Deposits (Placed as Margin) 1,121 0.20
Government Securities 460 0.08
PTC & Securitized Debt 156 0.03
Total Liquid Fund Corpus (Rs in Cr.) 570,577 100
Portfolio data as on August 31, 2018
(Source: ACEMF)

The table 3 shows, the allocation of the total corpus of Rs 5,70,577 crore together held by 41 liquid funds, as of August 31, 2018. Surprisingly, of this, about Rs 3,93,088 crore worth of assets are in commercial papers and about Rs 10,854 crore in Corporate Debt instruments. That's about 70.8% of the total assets in liquid funds. Notably only about 10% of the commercial papers held by liquid funds belong to Public Sector Banks, while 54% belong to NBFCs, which isn't safe either. The remaining 36% of the commercial papers held by liquid funds belong to corporate entities operating in other sectors. Liquid fund managers are clearly risking investor's money by betting on instruments issued by corporates, for higher yield.

As an investor, these are crucial questions to look into:

  • Are the fund managers holding exposure to these corporate instruments confident about its quality?
  • Have they done their internal risk assessment diligently?
  • How reliable are the ratings assigned to these instruments by rating agencies?
  • What if some other NBFC or a corporate group defaults tomorrow?

In this case, the Commercial Papers issued by IL&FS Financial Services were rated A1+ by ICRA; and so, they were considered to be high quality. Unfortunately, ICRA degraded the instruments by four notches to A4 only after IL&FS as a group failed on its commitment, least expected from a group backed by institutions like SBI and LIC.

So shouldn't even the rating agencies be held accountable for the mess they have created, by giving top rating in the first place, which is unreliable?

We consider this to be a systematic failure and expect regulators like the SEBI and RBI to take corrective measures so that the hard-earned money of small investors is not at risk in future.

Even fund houses need to have proper due diligence and internal risk assessment policies in place to avoid taking exposure in such groups and must not rely completely on ratings provided by rating agencies.

So can we expect the regulator to act strictly this time and come up with some stringent guidelines for mutual funds to protect the interest of investors who invest in liquid funds for safety?

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These are 5 hidden gems that most investors have probably never heard of, but still carry commendable management qualities and portfolio features and have superior potential to become category outperformers in the long run.

This report is very exclusive, so do not miss it for anything. Get access to these 5 undiscovered funds right now.

This article first appeared on PersonalFN here.

Author: Vivek Chaurasia


PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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