The fate of investors of the six closed debt funds and other fund of funds (FoF) investors will depend upon how quickly the Franklin Templeton fund house is able to sell all its securities. Though RBI's liquidity push of Rs 50,000 crore may prevent the spread of liquidity crunch to other funds in the near future, the FT investors' road to recovery looks distant. What are the challenges the fund house will face in selling off its assets and paying back the investors?
Higher the proportion of sovereign and cash investments of a debt fund, easier it is to wind up the exposure. However, the fund house has already sold most of its sovereign debt securities to handle the redemption pressure since August 2018. As per the report from B&K Securities, these six schemes faced a total redemption of Rs 20,879 crore till 23 March, 2020. Now, it is left with mostly corporate debts which will be very difficult to sell in current market conditions. As per a report from Transfin, out of total gross assets of Rs 29,171 crore on 23 April, 2020 the corporate debt asset is Rs 26,240 crore, which is almost 90% of the total assets.
Top 10 holdings key to liquidation
These six funds have the biggest exposure in top 10 holdings, which entail 45% of the fund's gross assets. If the fund house manages to sell these top 10 debt securities quickly, it will boost ability to liquidate the remaining assets.
It is easier said than done because none of these top holdings are sovereign or AAA rate debt. The greatest indicator of the scale of the problem is that the funds are left with no AAA rated securities in their top 20 holding. All securities are either AA rated or below. This curtails the funds' ability to find enough buyers.
Quickest recovery to come from AA rated securities
The only glimmer of hope is the next highest rate holding, which are AA rated securities. The funds have Rs 11,178 crore exposure in AA rate debt securities, which makes for almost 38% of the remaining assets. This is a big chunk and comparatively low hanging fruit which the FT schemes can sell at earliest.
Not easy to sell low rated securities
Though RBI has provided the liquidity window through banks, banks are unlikely to go beyond lending or buying securities with good credit ratings. When the conditions improve a little, the fund house may find some buyers for the investment grade papers in the secondary market. However, for low rate securities significant haircut seems unavoidable.
Tough task to sell illiquid debt securities
Debt securities where the funds are either the sole buyer or have bought more than 50% is another problem. There are almost 26 holdings where these schemes are the only lender with overall exposure of Rs 7,697.27 crores. The biggest hurdle which the fund will face is to sell these securities. The biggest 10 exposures of these funds account for Rs 5,080 crores.
Fresh shock to make recovery difficult
Holding till maturity is not an option because a good number of securities have maturity period of above 5 years. Therefore the fund house will have only option left is to find enough buyers in quickest possible time.
Since most of the funds tweaked their portfolios towards safer debt products due to RBI's action and better risk management following the NBFC liquidity crisis in second half of 2018, the risk of contagion appears low.
B&K Securities in its report says "We have analysed credit profile of the entire fixed income portfolio as on March end of Rs 13 lakh crore and approximately 83% of the same is in high rated instruments (Sovereign+Cash+AAA)." What it means is that major part of the debt exposure is into high rate debt and only 17% or around Rs 2.21 crore is in AA or lower rated securities.
"One hopes that this is a one-off case and we will not see more such cases even though the economy is yet to come out of this difficult phase," says Jasani.
FT investors can hope to get better realisation of their locked investment if the market sentiment improves. However, even in best case scenario, it will take time for the fund house to sell out the entire portfolio of the closed schemes. Even the most optimistic settlement looks unlikely before the last quarter of this year.
However, there are also chances of things getting worse. The impact of the coronavirus-related curtailed economic activity has yet not played out in full. Going forward, if there is any further shock to the economy and liquidity in the financial system, the road to recovery for FT investors will be much longer.