P Chidambaram: Franklin Templeton’s decision you wind up 6 mutual funds is a matter of grave concern to investors and the industry

[padraig_leigheanach]

He is explained how similar situation was handled in 2008.

https://twitter.com/i/web/status/1253984044733419520

 

[sammie2019]

@padraig_leigheanach PC is right in saying that this is mainly a liquidity related (actually illiquidity) stress event. Which can/should be managed by govt/RBI/SEBI providing liquidity to the AMCs.

The underlying bonds, even if they are less credit-worthy than others, have not defaulted. Yet. Whether they will do so or not is a matter of assessment. Without this lockdown event, things may have worked out or may not have.

However, given the situation, liquidity measures could have prevented such a winding down of these funds.

An analogy:

background:

1. you are a super speciality doctor, having practice at a corporate hospital, and a home loan.
2. the lockdown forced the hospital to lay you off (true for many, even in these times when doctors are much needed).
3. there is no relief by the RBI for home loan interest payouts. (This is what is different from the liquidity problem).
4. the doctor has other real estate assets too, but they are illiquid in the present market.
5. All his assets are unfortunately illiquid. But he had thought about his good and solid income from the hospital.

Now, the bank after seeing that 3 months EMI haven't been paid, declares the home as NPA and wants to takeover. They are justified legally.

The doctor could have paid the EMI from his other assets, but they are illiquid. He took extra risk without considering a black swan event like a complete lockdown. He still has the human capital to payout the EMI later. But by rules, the house will go for a takeover by the bank.

One can say, he should have kept emergency funds for 6 months or so. and since he didn't plan for this, he is the culprit and deserves this.

YMMV.

 

[montse811]

@padraig_leigheanach It's not the job of the Govt to save Mutual funds.

People bought Credit Risk & other funds because of outstanding returns in 2018 etc. While some poor saps bought G-Sec/Gilt/Liquid/FD funds with lower returns. People who bought these bought it for safety. Why should the Govt save those who took on more risk for more returns?

 

[breaf123]

@montse811 Answer me this:

Why is RBI giving 3 month moratorium to loans?

Those who took loans all thought they would repay it back , they were having outstanding lives and business in 2018 etc.. suddenly they are going for moratorium.

Why should RBI save loans and not MFs?

 

[montse811]

@breaf123 Technically, RBI hasn't made it mandatory for lenders to grant a moratorium on loans. If you read the circular wording, it says that the lenders are allowed to grant a moratorium (means they won't have to mark it as NPA even if they grant a moratorium which they otherwise would have to do).

 

[jermgray1]

@breaf123 The 3 month moratorium is completely different.

There your interest accrues and you ultimately have to pay your loan. So RBI does not pay anything out of it's pocket.

In this case if the papers default, why should the govt. pay? Where will the money come from? The redemption pressure is due to the risk of defaults. You cannot separate the two.

Providing liquidity is not the solution. The best RBI could have done is to freeze any redemptions so that if it defaults it's a loss for everyone who have risked with their money. Ultimately, by winding down FT has done the same.

 

[crixus123]

@montse811 I feel you're missing the forest for the trees.

Mutual funds invest in securities listed in the market. A debt mutual fund is no different.

When you're seeing an issue with a mutual fund, it usually signals a larger issue with underlying asset class.

It's not about protecting the investors who took extra risks. It's about intervening in a timely fashion, and not let the panic freeze the corporate bond market.

It's easy to feel I am smart enough to avoid this, why should I worry about what happens in some no-name AMC's credit risk funds. But everything's interconnected, and issues in one would inevitably spread to other assets that are linked.

There's a reason Fed's buying the junk bonds.

 

[path89]

@crixus123

There's a reason Fed's buying the junk bonds.

I still don't see the reason other than Trump wants a stable market in an election year.

 

[lukapyon03]

@crixus123 Maybe I am out of context, apologies beforehand.

Why aren't foreigners buying our debt? Currently we have news that the Chinese are looking out for bargains. Isn't our debt at least attractive than some of the other countries? Won't this provide liquidity in our bond market?

 

[crixus123]

@lukapyon03

Why aren't foreigners buying our debt?

NBIM, Norways's pension fund (world's biggest SWF), have recently sold a lot of Indian bonds. Read here.

This was big enough to trigger a scare among other foreign investors, that they might have liquidated as well.

Also, during times of crisis and uncertainty, people look for safe-haven assets. Bonds issued in USD by US or European Govt. would be something a bond buyer would look for.

Just like an average investor in Indian market would want to avoid corporate bonds and try to get into funds that deal with Govt. bonds / T-bills.

 

[montse811]

@crixus123

It's not about protecting the investors who took extra risks. It's about intervening in a timely fashion, and not let the panic freeze the corporate bond market.

The panic is because of real reasons. If the economy gets screwed because of the virus & lockdown, then companies which floated high interest papers would be the first to go bust (the reason they floated high interest papers was because they couldn't get money cheaper). So the debt fund with the high interest lower quality paper would have a lot of write downs & write offs. The panic is not unfounded.

There's a reason Fed's buying the junk bonds.

Yes, the reason is that they are stupid. I see no reason to buy junk bonds. Feds are also bailing out airlines (high capex industry) who have spent billions in share buybacks instead of keeping money for bad times.

 

[heliumskylark]

@montse811 There is no free lunch. Fed's buying junk bonds with money printed out of thin air. The cost of that will have to be borne by everyone else and future generations. This is akin to robbing Peter to pay Paul.

 

[nischansr]

@montse811 The risk that the fed decided to take in buying bonds is to try and ward off major business shutdowns down the line. Companies that rely atleast partially on rolling debt over will be forced to declare bankruptcy in a staggered fashion if the junk bond markets freeze or dry up. Debt markets are interlinked with the economy. It's not stupid for the fed to buy bonds if they are desperate to hold unemployment down. In a social crisis, that's a big factor, bigger than the headline of bailing out companies or buying junk bonds.

I have no opinion on what the Fed did. I'm just pointing out why they would do that.

 

[montse811]

@nischansr Yes, I understand why the Feds are doing this. But this is just kicking the can down the road for a bigger problem.

From the company's point of view, debt increases their profits in good times, but risks the company in bad times.
From the investor's point of view, he gets a higher interest premium because he is taking a risk as compared to the conservative guy who is investing in low interest low risk bonds.

If the govt bails out both these, it gives both companies & investors a perverse incentive to take risk because risk no longer comes with a penalty. This will screw the market for conservative investors & also for conservative companies who maintain a low debt capital structure (low debt capital structure reduces their profits in good times).

Every bailout leads to increasing the risk in the system.

 

[heliumskylark]

@montse811 It's no surprise that US investors in /r/investing are talking about going all-in on equity as Uncle Sam keeps pumping the market. Some investors feel the government won't let them lose money no matter how much risk they take. Risk premium itself will go for a toss if this perception continues.

 

[padraig_leigheanach]

@montse811 You may have your opinions, but across the world mutual funds are seen as a legitimate industry indicative a country's economy and financial sector. Indian MF industry has grown leaps and bounds over the past few years. MFs crashing and burning doesnt give the economy any credibility. Many funds closing down could easily trigger a series of crashes at unexpected places that may lead to bankruptcy of several business and all of these eventually may result in sovereign derating by rating agencies. You will never know what could catch fire next due to a domino effect. Infact some of the factors in Sovereign Rating Criteria include performance of the economy as a whole, stability of businesses, public finances. After all its taxes by businesses that keep a country able to pay its debt obligations. If a lot of companies that pay taxes wind up, then the country wont be in any position to honor its debt and India's soverign issuer rating will become negative. It will then take years if not decades to reverse this rot.

Fund houses arent asking to save mutual funds. Instead in a time of crisis its liquidity thats the issue not these companies going bankrupt (atleast not already). Govt/Central banks have the ability to provide liquidity in such a crucial time.

 

[montse811]

@padraig_leigheanach

but across the world mutual funds are seen as a legitimate industry

Where did I say they aren't a legitimate industry?

Fund houses arent asking to save mutual funds. Instead in a time of crisis its liquidity thats the issue not these companies going bankrupt (atleast not already). Govt/Central banks have the ability to provide liquidity in such a crucial time.

This isn't a liquidity problem across different kinds of debt funds. It's a liquidity problem only with debt funds which held higher risk paper for higher returns. This is exactly the risk which their investors got good returns earlier for. This was what the risk premium was for.

Why are GSec funds, Gilt funds & Conservative Liquid funds not facing a liquidity issue yet? What about those fools who bought those & suffered very low returns?

 

[padraig_leigheanach]

@montse811

Why are GSec funds, Gilt funds & Conservative Liquid funds facing a liquidity issue yet?

Your answer is in the last word - yet. This is only the starting.

This rot will slowly flow from low rated papers to high rated papers, and then to govt company papers.

Already over 300+ big companies have asked for loan moratoriums this includes tata power, JSW, air india group (govt), ONGC group (govt) etc. Several state govt companies are also in this list. Basically these companies are saying they cannot pay their debts in time. If the rating agencies reduce the ratings on this aspect, any fund holding these papers (including many highly subscribed liquid funds) should do a mark down.

This isn't a liquidity problem across different kinds of debt funds

This is the my fund is better than yours argument without realizing that this will very quickly spread to the whole bond market.

We can go on arguing the pros and the cons, what is right and what is wrong however if the central bank has the ability to infuse liquidity then it should

 

[montse811]

@padraig_leigheanach

This rot will slowly flow from low rated papers to high rated papers, and then to govt company papers.

RBI has already increased liquidity for investment grade papers.

This is the my fund is better than yours argument without realizing that this will very quickly spread to the whole bond market.

This is not a my fund is better than yours argument. It's an argument to not give people a perverse incentive to take risks & thereby increase the risk in the system.

if the central bank has the ability to infuse liquidity then it should

This doesn't come free of charge. Also there a lot more things govt could be doing now which they are anyway not doing. Most of India cannot eat if they do not work. Many of them are going hungry & many of them are gathering together to be fed by charities etc (thereby losing any benefit anyway of a lockdown). Migrants who want to go back to their homes are stuck without work & without any ability to get back. May be Govt to start aircrafts & helicopters to fly them to their homes (they could have done this a month back). There are 100s of things a govt could do.

 

[stumpy82]

@padraig_leigheanach I too feel this is the start of a contagion, these are extraordinary times which require extraordinary measures.