In October 2018, the National Company Law Appellate Tribunal (NCLAT) had issued an order putting all the assets of IL&FS under moratorium. The management of some of the SPVs decided they would not pay their dues to the lenders because of the NCLAT order. When one of the SPVs did not pay, rating agencies downgraded it to default category. This paper was held by ABSL MF. The fund house, then, had to mark down the fund that held this paper.
The other two fund houses had lent to the two other SPVs. They thought the debt papers of those two SPVs would also be downgraded, so as a prudent measure they marked down those papers, too (even though they have not been downgraded). Citing these developments, Icra put six funds from these three fund houses on negative rating watch and downgraded one (ABSL Short-Term Opportunities).
Experts say fund managers are not to be blamed for the current problems. “This time, the issue is not about whether there was credit risk that the fund managers failed to foresee. These are highly-rated papers that generate cash flows. It is more of a legal issue, pertaining to how the IL&FS affiliates should interpret the NCLAT order,” said Vidya Bala, head of research, Fundsindia.com. Moreover, these SPVs have a ring-fenced mechanism, which ensures the cash generated goes to the lenders. The whole purpose of this mechanism is to protect lenders to these SPVs from the troubles of the parent.
Bala says the investors in these six funds should wait to see how events unfold. On January 28, NCLAT will decide whether it is right to freeze the bank accounts from which coupon payments were made to these lenders. “The money is sitting in an escrow account, which means it cannot go to anybody else. So, it is a question of when, rather than whether it will come to the lenders,” she added.
Investors need to re-evaluate their own risk appetite in the wake of such events. “Downgrades, defaults and payment delays will happen from time to time. It is because of the higher risk they take that funds investing in lower-rated papers are able to give 100-200 basis points higher returns than funds investing in AAA bonds. If the current incident has spooked an investor, he doesn’t have the stomach for such risk, and should exit such funds,” says Kaustubh Belapurkar, director-manager research, Morningstar Investment Adviser India.
Such investors may alternatively put their money in funds that invest in AAA-rated papers. He adds that hopefully this issue will get resolved soon, otherwise it could set a wrong precedent and put a question mark on the sanctity of the ring-fencing mechanism of other such SPVs.