A lot has been written arguing for and against the move by HDFC AMC to provide a 'liquidity arrangement' for investors of Fixed Maturity Plans (FMPs) impacted by the exposure to Essel Group. This breather is for FMPs, which have either already matured or are due for maturity in September-end, when the mutual fund lender’s standstill agreement with the Essel Group ends.
What exactly is this arrangement? HDFC AMC will buy out the residual portion of the Non-Convertible Debentures (NCDs) of Essel, the promoter of the Zee group of companies, on which monies have not been paid to unitholders. So, the pending portion, which was earlier withheld, will now be paid back to investors. The maximum amount allocated is Rs 500 crore.
The Argument In Favour
The most important argument in favour of this move is that it is the fiduciary responsibility of an Asset Management Company (AMC) to protect the interests of investors. Unitholders never asked for the arrangement with Essel nor were they made sufficiently aware of it through adequate disclosures. Against this backdrop, it is only fair that an AMC of repute make good the losses investors face in the aftermath.
The natural question to ask now is — why not the investors in the open-ended schemes? Well, FMPs by their very nature carry a commitment by the AMC to be redeemed on a pre-decided date. That is not the case for open-ended funds.
Not paying full monies due required by the contract would open up the AMC to regulatory action and loss of trust at the hands of the investor. In fact, show cause notices have already been served by market regulator Sebi in this case.
That is not to say that FMP investors get everything back. The devil is in the detail.
On the date of redemption, HDFC AMC has committed to buy back the NCDs at “prevailing valuations”. What this means is that all negative rating action has been factored in and an adjustment made. Now, FMPs do not carry a promised return, but investors are likely to have their expected monies marked down to the extent of this valuation cut.
The Argument Against
The argument against this move is that these liquidity arrangements disrupt the notion that mutual funds are a pass-through vehicle. On a theoretical level, I agree with the principle that risk and reward should reflect in equal measure in the hands of the investors.
But there are many things left unsaid. For one, FMPs carry a contractual date of maturity and that investors were not aware until the eve of maturity that monies would be held back. For another, many FMPs were mis-sold as alternatives to bank fixed deposits. If theoretical principles are the root of this argument, then we have to rewind to the point of sale itself.
As far as setting a bad precedent for the future, you would recall a similar arrangement organised by Franklin Templeton in 2016 with respect to their JSPL exposure. Aditya Birla Sunlife had used this lifeline in 2009 when Wockhardt was on shaky ground, remember. There is also JPMorgan's famous Amtek Auto case.
Another argument and the more forceful one is that shareholders have been left to bear the brunt. Many questions have been raised about the impact of this move on the AMC's bottomline.
As on March 31, 2019, HDFC AMC had investments of Rs 2,935 crore . It is most likely liquidate Rs 500 crore from this investment in order to provide the required liquidity.
Come September, there could be mainly two scenarios. The best case would be that Essel Group pays back the lenders in full. In which case, HDFC AMC ends up making a profit because it is buying the NCDs at the prevailing valuation, which is discounted.
Even if one were to look at the lost opportunity cost of this Rs 500 crore invested in liquid funds at 7 percent a year, it would amount only to a maximum of roughly Rs 10 crore for the July to September period.
In the worst-case scenario, if Essel Group is unable to pay in September, It would most likely trigger an invocation of share pledge and a sell-off in Zee shares by all lenders. The Zee promoter shares are backed by a security cover of 1.2-2x across AMCs. So even assuming that the current market price erodes by 50 percent from here, it would amount to a loss of not more than Rs 200 crore for HDFC AMC.
But remember that as HDFC AMC now owns these pledged shares (bought back from unit holders) on its books, it would have more flexibility in timing the share sale.
Shareholder Interest Vs Investor Interest
This is where it gets interesting and the answer lies in HDFC AMC's red herring prospectus. Clause 17 says: 'We are required to prioritize the interests of our customers, which could conflict with the interests of our shareholders. In terms of the Sebi mutual fund regulations, we are required to avoid conflicts of interest in managing the affairs of our mutual fund schemes and keep the interest of our customers paramount in all matters. Accordingly, in the event of any conflict arising between the interests of our shareholders and the interests of our customers, we will have to prioritize the interests of our customers.”
In any case, for an AMC which controls nearly Rs 3.5 lakh crore in assets under management and reports a profit after tax of well over Rs 900 crore, this is a small price to pay to protect the brand and reputation as the market leader. It may not be an ideal move, but in a situation where the regulator has not come out and openly given a view on the standstill agreement or the FMP mess, it's the best one could have hoped for the hapless FMP investors.
