Securities and Exchange Board of India (SEBI) has asked fund houses to explain the rationale behind their investment in corporate debt. In a cautionary note, SEBI has asked fund houses to closely monitor companies in their mutual fund portfolios that have been recently downgraded. The purpose of the note is to avoid redemption crisis in debt funds as being currently faced by JP Morgan Asset Management Company.
The two debt funds of JP Morgan fund house — India Short Term Income Fund and India Treasury fund — were hit by the asset quality crisis. Both funds had collectively invested about Rs 193 crores in the bonds of Amtek Auto, an auto component maker, which was recently downgraded by Brickwork, a rating agency, to below investment grade due to deteriorating financials.
This resulted in a sharp drop in the valuation of the bonds and, as a consequence, a drop in the net asset value (NAV) of the two debt funds of JP Morgan. To prevent redemption pressure, the fund house imposed a redemption limit of 1% of the investment value from 28th August onwards. The fund house is now seeking approval from the investors of the two schemes to allow it to segregate the illiquid assets from other investments.
This entire incident has raised SEBIs’ concerns over the increasing exposure to corporate debt by domestic mutual funds especially, open-ended funds. There are regulations in place for close-ended funds while there are no such regulations for open-ended funds. In case of close-ended funds, you can invest only at the time of a new fund offer and exit before maturity is only allowed through the stock exchange. Whereas, in an open-ended fund, you can purchase and redeem your investment through the fund house on any working day. Therefore, liquidity risk is more in case of open-ended schemes.
The capital market regulator doesn’t want asset management companies and their trustees to take too much risk for their investors by investing in bonds of companies that have undergone rating downgrades in the recent past. Therefore, it has asked fund houses to closely monitor their investments in corporate debts.