The Hindu Business Line : Dealing with the FMP scare

Investors in FMPs may have had a much better understanding of the risk profile of these products, had they been told that the returns would be market-related.

Aarati Krishnan

Investors, seeking shelter from vicious swings in the equity market, have poured money into fixed maturity plans (FMPs) floated by mutual funds over the past ten months.

“Indicative yields” provided at the outset, protection from interest rate swings and lower tax incidence were the key selling points that helped fund-houses amass assets of Rs 1 lakh crore under the debt fund category until September.

But over the past month, an uncertain credit environment, concerns on portfolio quality for some funds and instances of premature redemption, have combined to raise questions on the image of FMPs as a safe-haven option. Both investors and advisors need to take note of risks inherent to FMPs and tread with greater care from here on.

The problem…

With a veritable flood of FMPs hitting the market, investors have been choosing between them based mainly on the “indicative yields” and “indicative portfolio”, informally provided by fund distributors during launch. In a deteriorating macro and credit environment, this has turned out to be a risky proposition. It now transpires that some FMPs offering a higher “indicative yield” have done so by assuming a higher degree of risk.

Exposures to debt paper from realty and finance companies, which offered better coupons, are now being viewed with extreme caution by debt investors, amid a liquidity crunch and a slowing property market. Portfolio concentration for some FMPs, with just 3-4 securities accounting for the entire assets, hasn’t helped.

A markdown in the prices of these bonds has hit these investments hard. There have also been reports of one or two funds not adhering to the “indicative” portfolios, triggering institutional exits.

Premature redemption requests from institutional investors have magnified the problem for FMPs.

Select funds have been forced to offload debt securities in an illiquid market to meet redemption demands, impacting returns, not only for those who pulled out, but also those who stayed.

Premature exits expose returns to swings in bond prices caused by interest rates — something an FMP investor is seeking to avoid in the first place.

Fund managers cannot be blamed for failing to foresee the problems created by a sudden deterioration in liquidity or a change in investor perception about credit quality.

There is little evidence even today, that funds’ exposure to triple-A rated corporates, top-rung NBFCs or large realty companies are facing the prospect of default.

Recent measures by the RBI to offer a line of credit to MFs, ease systemic liquidity and cut interest rates may also help the troubled funds tide over this problem.

A problem of mandate

However, fund houses still have to shoulder the blame for failing to read their mandate from investors correctly. To start with, they should have erred on the side of caution while investing FMP proceeds.

An investor who puts his money in an FMP on the strength of its indicative yield clearly values safety and predictability over high returns. That FMPs were all along positioned as a tax-efficient alternative to fixed deposits, only underlines this point.

Second, being fully aware of the limited liquidity of their investments, funds should never have offered a premature exit “window” on FMPs. It is best that products that invest in illiquid securities are completely closed end, so that an orderly unwinding is possible.

No ‘indications’ please

Finally, the very practice of informally “indicating” a yield on a mutual fund needs to be done away with. Time and again, it has been brought home to us that MFs which invest in market instruments cannot hope to offer a fixed return that is immune to market developments.

Investors in FMPs may have had a much better understanding of the risk profile of these products, if they were simply told that the returns would be market-related.

While yields should be left to the market, portfolios, to be provided in the offer document, should delineate the rating profile of securities to be bought. While the above measures may be brought in for new FMPs, investors also need more disclosures from the fund industry on the crop of FMPs already managed by it. The problems relating to FMPs are not industry-wide; they are concentrated with a few fund houses and schemes.

Measures needed

But, so far, investors have had to rely mainly on unconfirmed media reports to gauge whether a particular FMP or fund-house is in trouble. With investors already in a jittery mood, that is a sure recipe for ill-considered decisions.

Fund houses which manage FMPs, even those that aren’t in trouble, should disclose their current portfolios. The half-yearly disclosures mandated for closed-end funds may not suffice.

Detailed portfolio disclosures, backed by an opinion from the fund manager on its credit quality, may be required to reassure investors about their FMP investments.

Existing FMPs which have seen, say, 25 per cent, or more of their assets redeemed, should be required to notify and offer their remaining investors an exit option, so that those who stay on don’t suffer undue losses.

It is best that fund houses voluntarily come forward on these disclosures. That may restore investor confidence far more effectively than regulatory intervention.

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FMP yields trending down?

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