Did you just (F)uck (M)y (P)lans?

The financial market seems to have been entangled in Spiderman’s web. Just as the banks were slowly recovering from the set-back of non-performing assets, the default in payment obligations by Infrastructure Leasing & Financial Services (IL&FS) on term deposits (including short term) caught headlines. This failure had severe consequences, especially for the non-banking financial services (NBFCs) sector as the yields on their short and long term borrowings saw an uptick. No sooner had things in this space moderated, a new crisis has engulfed the financial market. On this occasion, however, the faithful investors who have a strong belief in the technical expertise of fund managers, investing their hard-earned money into a product named “fixed maturity plans” (FMPs) have been caught in a spot of bother.

What is this new crisis?

Who is the culprit at this juncture? Kotak Mahindra Asset Management Company, which has a product “Kotak FMP series 127”, was due for repayment (to its investors) on April 8, failed to repay the amount. Fixed maturity plans which are close-ended debt funds with a maturity period ranging from one month to 5 years are seen as an alternative to fixed deposits. To put it simply, the fund house collects a small sum of money from every investor wanting to invest in an FMP product for 1 year and consequently the fund house invests the same amount in a debt instrument (certificate of deposits, commercial paper, non-convertible debentures) of the same tenure (1 year). FMPs offer better post-tax returns than fixed deposits and also offers tax indexation benefits. The default will certainly be a jolt for the investors, corroborating the statement that “Mutual Funds are subject to market-risks, please read the offer document before investing”.

Reason behind the default?

Kotak Mahindra Mutual Fund, along with other fund houses had invested in instruments of Essel-group promoted companies which were backed by one of the group’s strongest media house “Zee”. Here, the term “backing” means that the lending was secured on the back of shares of Zee which were pledged to the fund houses. As some of these group entities defaulted on its payment obligation, the mutual fund houses were pressured in paying back the invested amount on maturity. What is interesting here is that the fund houses could have recovered the dues by selling shares which were pledged by Zee. But the significant fall in the share price of Zee made it difficult for fund houses to sell the shares as they would not have been able to recover the entire amount to be repaid to investors of FMP.

Diagrammatic presentation of FMP product with pledging shares

Who all are in the trap?

There are 94 FMPs have exposure to the Essel group companies. Kotak FMP has an aggregate exposure of Rs. 1,673 crs in the group entities as on December 2018. Kotak has denied its investors full payment of the payment obligations due in April and May’19 on the FMP product linked to Essel-group. Simply this means that the fund houses have not been able to pass on the amount which has not been received from these defaulting entities. On similar lines, HDFC Mutual fund, which is also a culprit in these scheme of things and has Rs. 902 crs invested in these FMPs, has told its investors to roll-over this scheme for another year i.e the fund house will make full repayment to investors due one year later from now.

What’s in store for the investors now?

The investors are now placed like the Royal Challenger’s Bangalore team in IPL where at the moment have lost their money and only time will tell whether they will recover from this precarious position. The only silver lining is that the Zee group is a good brand and have cash worth Rs. 1,200 crs in their books which assures the investors that the money will come back. Post this event the investors only have the wait and watch strategy to follow and for experience, the investors much note that debt funds providing higher returns come with high risk component. Such debt funds should not be compared with fixed deposits which are safer products.

The biggest take-away from all this for investors is that nothing is safe in the credit market: not even in the money which you lend to your beloved friends. On a lighter note, can investors invest in the safest asset of government treasuries or will there be a time when even they will default? Hope the central bank never lets this happen!!

Sushant Hede

14^th April, 2019