Usually, it is unfair to be critical of an industry just because of the practices of a few players. However, the recent repayment issues surrounding mutual fund fixed maturity plans (FMPs) require a strong response from investors, stakeholders, commentators and the regulator. Fixed maturity plans are debt funds that come with a maturity date. It is a close-ended product, with no real exit option apart from the maturity date. On the maturity date, the investors get their original investment along with applicable return due to interest earned from loans given to corporates. FMPs have been marketed with huge commissions for the distributors, which is a reason why FMPs were, erroneously, compared with bank fixed deposits. Today, when the country’s top fund-houses are extending the maturity of FMPs or telling investors they cannot pay the full redemption proceeds due to lack of clarity in one/two investments, they cannot say they did not see this coming. The harsh truth is the mutual fund industry has become arrogant. They keep on talking about 'investor', but it may seem an eye-wash. When they cannot keep the commitment made to investors, they have no right to compare some products with either the bank deposits or their often-targeted rival, the insurance industry.
FMPs have collected a lot of money. In 2014, 2015 and 2016, over Rs 34,000 crore was raised. A lot of that money is coming up for pay-day. Let us go back a little to understand what happened with FMPs today. Investors in at least two fund-houses (Kotak and HDFC) have now realized they will not get back their full redemption proceeds on the original maturity dates. Why did this happen? It is chiefly to do with debt exposure to Essel/Zee Group. About Rs 7000 crore debt was given to the Essel group by MF industry, with Rs 1700 crore worth given by FMPs alone.
Many FMPs took 10-20% exposure to the group. Since the group is in now in financial trouble, the money cannot be returned. In the financial world, this is called a default. Fund-houses had taken shares as the security of the group so that they can sell it off to recover money if the money is not paid on time. That is how the concept of 'security' works. But the rules have been rewritten by the Indian MF industry! They did not sell the shares, arguing selling by everyone would push prices lower. If the value of a security goes down so much, it cannot really be called 'security'. Since Essel/Zee group is in trouble, fund-houses simply gave the corporate group time till September 30 to repay. And you as an investor, have to wait. Is there a guarantee things will get better by September 30? No.
Risk and misadventure
Today, mutual fund experts are coming on TV and telling investors that FMPs do not have any guarantee. So, why were MF distributors and MF officials earlier comparing FMPs with banking and insurance products? They never spent as much time, as they do today, in explaining to all investors the extra return in FMPs comes with extra risk. The risk in FMPs is out for the entire investor community to see. If you made an investment in a 3-year FMP with a goal of using the money for something like a home loan downpayment, or child's education fees or even wedding expenses, you have to wait. Can you wait? We all know the answer.
Some of the so-called MF industry experts have the audacity to crack jokes on how investors are intelligent with the benefit of hindsight. Investors are not supposed to be experts. If they were experts, they would never trust somebody else with their money management. So, the fund managers, paid tens of lakhs and even crore in annual salaries, are expected to do their job. Nobody expects investing to be a zero-error profession. It comes with risks, but not all products have the same level of risk. If FMPs can face 10% loss, they are not debt instruments.
If the risk of permanent capital loss is so high, can we call FMPs or any mutual fund debt products 'fixed income'? No, we cannot. It is much better to invest in equity funds for the long-term. The usual argument in favour of debt fund products is that taxation blow is softer compared to bank FDs. Bank FDs do not default. They mature on time and you get paid on time. The interest rate promised in a bank FD is delivered, always and on time in scheduled commercial banks. Next time somebody comes to you to sell FMPs, remember these things.
Asleep at the wheel
There will be mistakes, but instead of being sorry about it, today the arrogant MF industry is trying to blame the investors for investing! This is absolutely ridiculous. Why should the MF industry be sorry? Yes, there are multiple reasons why it should.
Firstly, investments are always about a diversified portfolio approach. When an FMP invests 10-20% in a single group, they are really not diversified at all. This has come back to bite investors, not the fund-house.
Secondly, problems at the Essel group were known from January itself. Even when the IL&FS defaults happened, the fund industry was not pro-active. It was reactive. When problems at Essel group reared their ugly head, the MF industry never told investors that there was a strong chance that money may not get repaid on time. They should have; financial propriety demands such an action.
Thirdly, the MF industry cannot duck the obvious question - if the debt investments were 'secured' by shares in Zee Entertainment, what is the use of 'security' if it cannot be liquidated? When a retail borrower defaults on a home loan, by the 4th month the bank/financial lender ensures that the borrower loses the home or pays up money. But when it comes to corporate borrowers, the same rules - strangely - do not apply.
RBI must regulate
There are deeper questions about whether fund-houses are doing enough to protect investors' interests. Why are fund-houses bending their back to accommodate interests of corporates? Whose interests is the MF industry really serving? Many believe that the time has come for mutual funds to be supervised by the RBI. The SEBI is a capital market regulator and is doing a fine job. However, mutual funds, especially the debt side, today has become large and are giving lakhs of crores as loans.
As a lender, mutual funds have to be supervised and strictly regulated by a regulator that is an expert in these matters - the RBI. Banks, NBFCs and peer to peer lenders are already under RBI. The mutual funds need to be drafted under the banking regulator too, because otherwise, they will keep on taking liberties.
Dear reader and investor, you must remember a few things. Not many in the MF industry will tell you these things when they come to, again, to sell their products.
1. Debt funds including FMPs are NOT bank FDs. The returns from a mutual fund are not guaranteed under any circumstance. So, don't look at the historical return and expect your investment to give similar gains.
2. Debt funds suffer from high liquidity risk. There is obviously an inability of the fund to sell its investments and meet redemptions of investors. There is hardly a way out of this mess when trouble happens. So, it is better to stick to mutual funds that only invest in debt securities of the best of the best companies and institutions.
3. Do not invest in debt mutual funds for returns. Debt mutual funds, including FMPs, are not for generating any real wealth. If you want to generate real wealth, invest in equity funds but they come with different, and of course, higher risks.
The author is a journalist with 14 years of experience