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This article is a concluding one in a series of articles I have written on Amtek Auto default fiasco (TRIOLOGY). Kindly read my earlier articles on this subject:
Stay Away from Chinese Whispers(Click Here)
Can We Rely on Rating Agencies? (Click Here)
Before I conclude my story on Amtek Auto fiasco, let us go back a few years when we faced similar situations (not credit risk but interest rate risk story) & knee jerk reaction of the entire industry. Let us understand the basics of investing in debt markets first, risks involved & what should one do at various points in time:
What are the risks involved in Debt market investments?
Interest Rate Risk: When interest rates go up, NAVs of debt schemes go down & vice versa. Which means that there is reverse correlation between NAVs of debt schemes & interest rate movements. Investors have been sensitized to this risk over a period of time by explaining the concept of Marked to Market (MTM) & reverse correlation as explained above Liquidity Risk: when a Fund Manager has to sell some securities in distress due to redemption pressure, there is liquidity risk attached to debt scheme investments. This risk can arise in pure liquid schemes (with less than 60 days in residual maturity) like what happened during 2008 Lehman Brother crisis. Investors are even aware of this risk Credit Risk: though investors are aware of this risk arising out of default/delay by the borrowing company; they refused to accept this risk arising in their portfolios as till date most AMCs took the loss arising out of this risk on their balance sheets (like Deccan Chronicle default). Since the AMCs so far said "Main Hoon Na" we put blinkers on our eyes & ignored this risk till Amtek Auto default happened & the concerned AMC refused to bear the brunt of this risk & passed it onto investors. Even after Deccan Chronicle fiasco, Advisors & Investors chased higher YTM schemes; thereby throwing caution to the winds on the risks arising out of Credit
Interest Rate Risk
This keeps on occurring in Investor portfolios from time to time based on interest rate movements. Recent huge corrections due to volatile interest rates were felt in 2008-2009 when Income schemes recommended in 2009 January posted huge negative returns thereafter due to rise in interest rate against the reverse expectations.
Similar story was repeated to Income scheme call given in the beginning of January 2013. This call generated huge positive returns from January to April 2013. Between May & June 2013, it generated negative returns as Fed announced that they will do tapering of QE sometimes in future. Those who had invested in the beginning of the year still generated positive returns from then to June end. However, those who invested during months of May & June 2013 were in for a rude shock. Most Income schemes garnered maximum AUMs during these two months & the same started tapering off v/s increase in AUMs of FMPs as is evident from below:
I had written an article that time titled: Stay Clam, Think Logically & Do Not Panic(Click Here). RBI raised interest rates in June 2013 against expectation of cutting interest rates & took some liquidity tightening measures in July 2013. 10 year benchmark peaked to 9% thereafter. All investments made in May & June 2013 started posting huge negative returns (due to interest rates going up) & industry gave an aggressive call for redeeming out of Income schemes & investing into 12 month FMPs with 10-10.50% p.a.
Following tables will depict the impact of Knee Jerk, Irrational Decisions taken by the Industry in 2013
Table A above depicts value of Rs.1 crore investment (average of 12 top Income schemes) as on August 2013 when interest rates peaked & investors panicked looking at the losses.
Table B above depicts two scenarios: a) those who stayed invested in these Income schemes from May 2013 till August 2014; thereby posting +1.82% p.a. b) Second scenario is the impact of an Investor investing in Income schemes in May 2013; booking losses by redeeming from Income schemes in August 2013 & then investing the remainder amount of Rs.91.86 lacs (post loss) into FMP of 12 months @10% p.a. This investor thereby generated lower return of 0.85% p.a. v/s 1.82% p.a. for the investor who stayed invested in Income schemes
Table C above depicts the portfolio of an Investor who invested in Income Schemes in May 2013 & held onto the same till August 2014 plus adding on further investment in Income schemes when interest rates peaked in August 2013; thereby generating a healthy +6.05% p.a. on the entire portfolio of Rs.2 crores (my call of Hold & Buy)
Lessons learnt from above
First & foremost, do not rely only on point to point (P to P) returns to select an asset class - in this case debt schemes. When an asset class like debt posts huge positive returns, 90% of times the story is already over. Most investors invested in Income schemes (looking at P to P returns) in May & June 2013 as is evident from increase in AUMs of Income schemes during these two months; whereas they should have either redeemed or stayed away from these schemes looking at P to P returns which had become unsustainable When interest rates peaked in August 2013 (thereby generating huge negative returns in Income schemes); based on the concept of MTM, most of the negatives were already factored into the NAV of debt schemes & hence, this was the time to hold or add into Income schemes & not redeem (my call at that time) This is the time to take a step back, think logically & not panic & take irrational decisions (which most Advisors & Investors took by redeeming from Income schemes & getting into FMPs). They in turn converted notional loss into actual loss (which became irrecoverable) Debt schemes can generate maximum returns going forward only when an Investor has invested at peak of interest rate cycles. Both Accrual & Duration schemes can generate better returns if invested at peak interest rates (whereas Investors were doing just the reverse of redeeming at the worst time) It is like investing in equity at lower SENSEX (which is equivalent to investing in debt schemes at higher interest rate levels & vice versa)
Credit Risk
Now coming back to present & recent events around Amtek Auto fiasco
Following is the chronology of events leading up to J P Morgan putting gate for redemption & segregating stressed & unstressed portfolio by issuing additional units for stressed assets:
Rating of Amtek Auto by Rating Agencies on different Dates
Based on the above chronological events & investor actions, let us analyze the impact on investment of Rs.1 crore in J P Morgan Short Term Plan (JPM - STP) say on June 1' 2015
Lessons Learnt
Investors have to be sensitized to Credit Risk while investing in debt schemes Highlight the benefits of diversification through the MF route. In the case of Amtek Auto exposures in some schemes, at least 90-95% of the funds were available for investors to redeem v/s pitfalls of say investing in NCDs of Amtek Auto & losing 100% of the portfolio Again, knee jerk reaction & redeeming without analyzing the situation logically (before segregation in schemes units between stressed & non stressed assets), an Investor would have never recovered money stuck in the stressed assets Investors were saved from their own irrational behavior by the AMC putting gating & restricting redemption from August 27'2015 onwards till December 07'2015 (refer to Table D) By being patient &letting the AMC work on recovering dues from the borrower, investor could have recovered 100% of their principal amount invested in the beginning plus some returns (2.21% in the above example-Table D) Even on the day when CARE suspended rating of Amtek Auto on August 07'2015; investors & advisors should have taken note of this developments & redeemed out of the said schemes. JPM Short Term Plan on that day still generated 6/7/8% p.a. returns over past 1/2/3 years Do not rely only on Credit Rating Agencies for selecting MF schemes. Liquid Plus scheme of the concerned AMC was rated AAA by CRISIL till September 01'2015 (way beyond the dates of suspension of rating by CARE& downgrading of rating by Brickworks on different dates) >More importantly, besides just the issue of Amtek Auto & its impact on two of the schemes, Industry (read Advisors & Investors) were in a mood to exit out of all accrual themes where there were perceived credit issues. This would have been a huge disaster for the entire MF Industry as a whole as redemption pressures on other schemes of other AMCs would have created huge liquidity risk as some of these debt securities with lower Credit Ratings would have been illiquid assets. In the bargain we would have created a liquidity risk rather than an actual credit risk in the industry. Better sense prevailed in our industry due to proactive steps & communications done by AMCs, some Advisors (including Yours Truly - through my two articles published during this period) & there were no redemption pressures due to perceived credit issues.
Hope above acts as a guide in future for the Industry as a whole in terms of not reacting to any such events with irrational & knee jerk reactions & decisions. One needs to understand basic concepts of investing in debt markets & risks involved in the same, sensitize the investors to both & then take some informed investment/disinvestment decisions.
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