Time For The Regulator To Act Tough
A tacit understanding has been reached last week between couple of promoters and mutual fund houses. The understanding is that the MF houses will not sell the pledged shares of the promoters till September 30. If the value of the shares goes below a threshold level, it will fail to cover the loan amount. The incident that led to such an arrangement between the promoters and MF houses shows how deeply the debt and equity funds are intertwined, which may be jeopardising an investor’s asset allocation plan.
MFs mostly give funds to promoter of a company under the debt segment schemes such as credit risk, short-term and medium-term plans and dynamic bond funds by accepting their listed shares as collateral. As the value of shares falls, MFs start selling these shares and the share value drops further as supply outstrips demand. This starts a vicious cycle that impacts both the shares of the company and the debt funds. Many a time, the treasury department of the company whose shares have been pledged invests in debt funds issued by the MF house that has extended loan against shares (LAS) to the promoters. This shows how deeply they are interconnected and throws up a possibility of the debt fund going belly up.
LAS is not something new and has been in use over the last couple of decades. Nonetheless, in the last few years, and especially after demonetisation and the fall in interest rates, LAS has increased considerably. The strong inflow of investible funds along with lesser number of opportunities to generate better returns led to the chase for yields, leading the fund managers to take risky bets such as LAS. The problem is that as most of the investors invest in debt funds for their safety, LAS defeat this very purpose.
Therefore, this is an apt time for the regulator to act tough and force the MF houses to make more elaborate disclosures for debt schemes that have promoter-backed bonds in their portfolios. This will help investors to select the right debt mutual funds that match their risk profiles.