On June 4, DHFL failed to pay the interest due on some of its debt instruments. This failure triggered a downgrade of its debt instruments by rating agencies. DHFL had been a AAA-rated company at the end of 2018. By May this year, it had been downgraded to BBB-, and last week its commercial papers and longer-term bonds were downgraded to D or default rating. Valuation agencies marked down the valuation of its bonds by 75 per cent. As a result, the net asset values (NAVs) of funds that had high exposure to these bonds were hit hard, some to the tune of more than 50 per cent.
Will valuations of DHFL bonds recover? DHFL has said that there has only been a delay in payment, and that the company is allowed a seven-day curing period during which it can pay up. But DHFL’s troubles will not end even if it manages to make this payment. Rating agencies believe that DHFL’s liquidity problems will continue for at least the next three months, as it has large repayment obligations coming up. Rating agencies have said they do not have adequate visibility that DHFL has the liquidity to meet all these obligations. Refinancing has become impossible for the company, given the negative sentiment surrounding, while the securitisation of loan books and strategic sales in group companies are proceeding slower than expected. “Only if DHFL is able to find a large equity partner in whom the market can trust will it be able to gain the market’s trust and get refinancing for its loans,” says Arvind Chari, head of fixed income, Quantum Advisors.
Why the high losses? Some funds took a hit of more than 50 per cent to their NAV within a single day, something that took most retail investors by surprise. According to rules stipulated by the Securities and Exchange Board of India (Sebi), there is a 10 per cent limit on the exposure a fund can have to a single issuer. Yet, some funds had as high as 37 per cent exposure to DHFL papers, resulting in a dramatic loss of value. “When the crisis started, these funds were within the stipulated limits. But thereafter they faced redemptions. They could not sell papers like DHFL as nobody would buy them, and were forced to sell quality papers. As a result, the proportion of DHFL papers rose in many portfolios,” says Kaustubh Belapurkar, director-manager research, Morningstar Investment Adviser India.
Impact of this event: In the short-term, credit events related to companies like IL&FS, Essel group, and DHFL have definitely eroded investor confidence in debt funds, as is evident from the significant outflows these funds have witnessed. Experts say these events will change investor perception about debt funds. Investors will realise that debt funds are not as safe as fixed deposits. They do carry credit and duration risk, which they need to watch out for carefully at the time of investing.
Second, investors should not enter a fund category merely by looking at its past returns. They need to realise that many categories like credit risk may offer higher returns but also come with higher risks.
Over the longer term, say experts, such events will bring in a semblance of maturity into the markets. Investors will enter these funds with a greater understanding of what credit risk entails—that they could even lose their principal if things go wrong.
What should investors do? Investors may decide based on the quantum of losses. “Where the quantum of loss is very high, say 50 per cent, it could take investors six-seven years to recover their money. Such investors would be better off cutting their losses and exiting,” says Nikhil Banerjee, co-founder, Mintwalk. Such investors may stay on only if they want to wait and see whether the company is able to garner funding support from an external source.
If the quantum of your loss is in the 10-20 per cent range, then investors may stay put. “DHFL has shown an intent to repay its loan. It is a liquidity issue and not a solvency issue. DHFL’s underlying asset quality of retail loans remains healthy. So, the chances of things getting better are higher than that of things getting worse,” says Belapurkar. He adds that investors will have to be patient as the pace of rating upgrade and valuation markup will not be as rapid as the pace of markdown.
If you decide to stay put, look at the quality of the rest of the portfolio. “Make sure that there are no other low-quality papers in the portfolio,” says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisors.
| 10 funds with highest DHFL exposure, and the NAV hit they took on June 4 | |||||||
| No | Fund Name | DHFL Exposure (%) | DHFL Exposure (Rs cr) | Fund AUM (Rs cr) | NAV-June 3 | NAV-June 4 | Impact on NAV (% ) |
| 1. | DHFL Pramerica Medium Term Fund | 37.41 | 12.91 | 34.51 | 14.72 | 6.92 | -52.99 |
| 2. | DHFL Pramerica Floating Rate Fund | 31.94 | 4.18 | 13.10 | 20.92 | 10.80 | -48.39 |
| 3. | Tata Corporate Bond Fund | 28.21 | 51.93 | 184.06 | 2,275.95 | 1,600.32 | -29.69 |
| 4. | Baroda Treasury Advantage | 21.16 | 114.74 | 542.19 | 2,169.12 | 1,797.19 | -17.15 |
| 5. | Principal Low Duration Fund | 19.24 | 46.29 | 240.61 | 2,943.29 | 2,455.29 | -16.58 |
| 6. | DHFL Pramerica Low Duration Fund | 20.12 | 62.19 | 309.16 | 25.75 | 21.48 | -16.57 |
| 7. | DHFL Pramerica Short Maturity Fund | 30.46 | 91.43 | 300.13 | 33.41 | 28.88 | -13.55 |
| 8. | Edelweiss Corporate Bond Fund | 15.00 | 22.43 | 149.57 | 14.35 | 12.43 | -13.40 |
| 9. | BNP Paribas Medium Term Fund | 14.84 | 20.69 | 139.39 | 14.54 | 12.67 | -12.88 |
| 10. | Tata Medium Term Fund | 14.60 | 8.99 | 61.60 | 28.40 | 24.91 | -12.31 |
| Source: Morningstar India | |||||||