Unit holders of debt schemes of mutual fund houses, which are holding debt paper of various IL&FS group companies, are at risk of losing their money. The probability of default by the IL&FS group companies is supposed to have increased in the last few days as some of them were not able to meet their repayment schedule to financial institutions. Default by companies is not a new development. But the involvement of IL&FS, which was professionally run and managed, raises questions of business practices and puts a shadow of doubt on practices followed by ratings agencies and mutual fund houses.
As far as ratings agencies are concerned, they merely acted as forensic doctors – doing the post-mortem when everything was over. The ratings downgrades happened at the last moment when the default was about to happen. Downgrading the rating on its debt paper by bringing it just one notch lower and then in one month bringing it down further – almost minutes from the default betrays a lack of proper processes. It needs to be asked what role the ratings agencies played when year after year the debt in IL&FS books kept increasing and cash flow dwindled. Their rationale appeared to have been that since IL&FS had institutional shareholders, they would come to its rescue, and hence there was no need to go by what numbers showed – the last thing which a ratings agency should do. The regulator should look into the working of these ratings agencies, which while claiming to have expertise in deciding on the health of companies, have actually failed to deliver on several occasions in the past.
Another issue relates to the fate of investors of debt schemes where IL&FS paper is held. If there is a default, will the market regulator ask the AMC to make good the losses? When such defaults happened in the past, fund houses that had the backing of large houses or had a global parent absorbed the losses – in those cases they transferred debt paper to other companies. However, when an asset management company (AMC) put the burden on investors in resulted in hurting net asset value (NAV) of the debt scheme. While the fine print of a debt scheme document concedes that default by corporates on a bond is a possibility, for investors the priority is safety of capital rather than returns. An IL&FS kind of case shakes investors’ faith in debt schemes.
Probably the time has come for Sebi to make it mandatory for fund houses to make public their track record as far as debt schemes are concerned. It is important for investors to know whether as fund houses the fund manager invested in debt papers, which ended up in default, who foot the final bills of that default, AMC or investors and what will be done in case of a default. Investors need to be told if there was a hit to any scheme and what happened to the trustees who are protectors of unit holders. Such information should be displayed prominently so that unit holders are aware of risks in a debt scheme.