Are Debt Mutual Funds Going the NPA Way?

For years now, investment wisdom – when it comes to mutual funds – used to be that for more risk-taking individuals, equity funds was the way to go, whereas for risk-averse ones, debt mutual funds were the safe bet. The idea behind the argument was that debt mutual funds relied on steady returns as the investors would be paid as debtor companies paid back their loans. What most wealth management advisors and gurus, perhaps, missed was the situation when the company is in no position to pay back the loan. What happens to the investors’ money then?

To be fair, in a bull market, few think of the possibility that loans of multiple reputed companies would become non-performing assets (NPAs) together. No matter how far-fetched it may seem during a bull market, that is exactly where the Indian financial market has found itself today.

After all, it is not just non-financial banking companies (NBFC’s) – like IL&FS – that lend to private companies. It is the same business model that keeps mutual funds afloat. Hence it won’t be surprising if a few mutual funds are found to have exposure in the same private companies that IL&FS did.

Just earlier this week, the repayment capability of Subhash Chandra’s Essel Group was brought in question when the company sought time till September 30 to pay back the money it owed to lenders – interestingly, both NBFCs and mutual funds.

Several mutual fund plans of Kotak Mahindra and HDFC have already declared exposure to Essel by delaying, or giving option to delay, the redemption of their plans till Essel pays back the debt.

The question remains if Essel would serve its debt by September 30. In case it doesn’t, which is not a very unreasonable possibility in today’s financial market situation, these mutual funds would be hit by the NPA problem – just like banks first and NBFCs later – to the extent of their exposure to the company.

One may wonder if one instance of default by one company – albeit it’s a group of companies including Zee and Dish – should spook the investors and bring in question the “safe bet” aspect of the debt mutual funds. But consider the fact that Essel Group’s 15 investment companies and dozens of subsidiaries had alone run up an unsustainable debt of over Rs 17,000 crore. Add to this the fact that this is not an isolated incident of default to debt mutual funds. In fact, several mutual funds had exposure in IL&FS, which itself is facing insolvency proceedings.

With several debt funds investing in private companies with opaque structures, rising debt levels and investments in non-core activities, there is a reasonable possibility that it could just be the tip of the iceberg with more shocks to come in future.

In such circumstances, the individual investor should not be swayed by the promises of “safe bet” by investment advisors, but should evaluate debt funds with same diligence as equity funds before investing in them. Balanced funds could be relatively better options, but one should remember, no investment is completely safe and due diligence needs to be done before any kind of investment.