The events surrounding the liquidity crisis at Amtek Auto, followed by restrictions imposed by JP Morgan AMC on redemptions in two of its schemes over the last week, have once again raised concerns over ratings of debt papers and fund management practices. And these have wider implications for retail as well as institutional investors.
Three years back, Care Ratings had maintained its highest rating (A1+) on Deccan Chronicle Holding’s (DCHL) short-term paper despite the company defaulting on its liabilities. The issue raised questions over the sanctity of the ratings provided by the agency then. This year, too, similar questions are being raised over the agency’s decision to maintain its high rating on Amtek Auto till May 25, 2015, even as the company’s financials turned from bad to worse. Ten weeks later, the agency suspended its rating on the company saying that Amtek Auto was not furnishing the required information to them.
While several banks, three years back, saw their money getting stuck with DCHL, this year JP Morgan AMC has seen redemption pressure on two of its debt schemes that has investments of around Rs 200 crore in Amtek Auto. If industry insiders are questioning the rating, mutual fund managers say that bulk of the responsibility lies with the fund management company as they can’t just rely on the ratings of agencies and need to do proper due diligence before putting investor’s money into corporate bonds. The CEO of a leading fund house said, “In this case the fund house is at a larger fault because they were the custodian of investors’ money and they did not do their due diligence properly. In fact, they were the only ones to subscribe to the papers of Amtek Auto.”
In an email response, Care Ratings said that the two cases (DCHL and Amtek Auto) are not comparable and said that the DCHL case was, “an instance of alleged financial irregularity committed which is presently under investigation by various authorities. In case of Amtek Auto, Care had been rating its debt instruments since about 20 years.”
On the issue of a rating revision on Amtek Auto long after the firm’s financials came under pressure, Care said, “The lowering of the long term rating in May 2015 took into account the decline in financial profile marked by drop in sales and profitability in the quarter ended March 31, 2015, and risks related to aggressive pace of acquisitions made by the company in the recent past. However, upon non-cooperation by the company, the ratings were suspended in August 2015.”
A senior official with another leading fund house said that though they go through the ratings offered by the agency as a preliminary check, they do not base their investment on such ratings.
“Ratings from credit rating companies can at best be a starting reference point when an investment proposal comes. While there is some good work also being done, we primarily rely on our own credit research team, systems and processes, and our investments are purely based on the due diligence and recommendation of our own research team,” said Amit Tripathi, CIO-debt at Reliance Mutual Fund. He further added that there have been numerous occasions where his fund house has deferred with the view of rating agency and have gone against an investment proposal. “Ratings may also rely more on stated numbers while we have to go much beyond the given data to arrive at investment decisions,” he added.
Agreeing to this, a senior official with another leading fund house also raised the issue of credibility of ratings. He said that within the fund management community everyone avoided Amtek Auto for investment purposes as they were not comfortable with “corporate governance practices” within the company.
A look at the shareholding pattern of Amtek Auto shows that mutual funds’ holding in the company stood just at 0.53 per cent in June 2014 and it rose to 1 per cent at the end of March 2015. However, following a sharp decline in the share price of the company over the last few months, some fund houses increased their holding in the company and the aggregate mutual fund holding in the company went up to 2.5 per cent at the end of June 2015.
“The equity holdings of leading fund houses show no exposure to Amtek Auto and it is very strange to see that if fund houses are not comfortable with investing in the equity of the company, how can they go ahead with exposure to its debt paper,” said Prasunjit Mukherjee founder of Plexus Management Services, a mutual fund research and advisory company.
Mukherjee also pointed out that investors pay fund management fee to the fund house to keep “their ear to the ground” and so the fund house holds the sole responsibility if an investment goes wrong. While a debate has been going on the business model of rating agencies, the head of a mutual fund firm said that as of now the revenue of the credit rating agencies comes from the issuer itself. “I think it will be more credible when the investor pays for the rating,” he said.
What’s in it for the investor?
Since the liquidity issue at Amtek Auto came to the fore, investors have been queuing up to redeem their holdings in the two debt schemes of JP Morgan — Short Term Income Fund and India Treasury Fund — that have exposure of around Rs 200 crore in the auto ancillary company. While this resulted into a decline in net asset values (NAVs) of the two schemes as a result of the mark-to-market losses, JP Morgan AMC put a cap on redemption at 1 per cent of the total number of units outstanding on any day.
Investment experts, though, have been critical of such a step of the fund house, they suggested that the investors should not liquidate their holdings from the scheme in a hurry as that will put pressure on the scheme’s returns.
“Unless these are the only schemes that an investor has invested in and he is in need of the money, he should not rush to redeem his holdings in these schemes. If one needs the money one can redeem other holdings that are doing well,” said Surya Bhatia, a Delhi-based certified financial planner.This is also a lesson for the investors that debt investments in mutual funds too carry risk and they need to be aware of the risks while investing.
The three main risks that they carry are — credit risk where the bond issuer fails to make timely interest payments and repay the principal amount on maturity; liquidity risk where the fund manager is not able to sell his paper due to lack of demand for a particular security and; interest rate risk where a change in interest rate changes the price of the bond.