DHFL Exposed Debt Funds Take A Nasty Knock. What Should Investors Do?

Several Debt Mutual funds took a nasty hit yesterday as beleaguered housing finance player DHFL failed to pay back a sum of around Rs. 960 Crores to lenders yesterday. NAV’s (Net Asset Values) of debt funds that held DHFL paper plummeted between 6% and 53% in a single day, since AMC’s are mandatorily required to mark down papers of defaulting borrowers by 75% to 100%. Some 160 odd debt mutual fund schemes were invested in DHFL paper on the date of the default, and they had to follow the mandated haircut rules laid down by SEBI, resulting in the drop in their NAV.

DHLF Pramerica Medium Term Fund, DHFL Pramerica Floating Rate Fund & TATA Corporate Bond fund were the three biggest losers, taking hits of 53%, 48.4% and 29.7% respectively.

According to sources at AMC’s, many funds were trying to offload DHFL paper for quite some time now; but could not, due to weak demand for the same. As redemption pressure mounted, they were forced to sell liquid paper to meet obligations, and hence their holding in DHFL as a percentage of the total portfolio grew, crossing the SEBI mandated 10% single borrower exposure in case of many funds.

Keeping the burgeoning number of defaults in mind, SEBI had allowed AMC’s to follow a practice called “side pocketing” in a circular released in December. Put simply; side pocketing involves shaving off the defaulting paper into a separate “subset” of the fund with a different NAV. Only the investors who were present in the fund on the date of the default would be allotted units to this “mini fund”, so that the benefits of future recoveries flow solely to them, and not to other investors who would buy into the fund immediately after a default, at a heavily depressed NAV.

However, according to AMC sources, very little headway has been made by AMC’s on setting up the side pocketing mechanism, which would no doubt entail complicated data flows and operational complications. It seems that AMC’s more or less sat on the circular for the past 5 months, and the regulator did precious little to push things through as well!

It’s far more likely that AMC’s who had a heavy exposure to DHFL paper will follow the shortcut route of suspending fresh subscriptions to the fund until this fiasco plays out in entirety. So, the question is, what should investors in thee hammered debt funds do now? Well, for one, a delay in payments does not technically constitute a default, and DHFL has up to seven days to pay up. It needs to be seen if DHFL is able to honour its payments.

If DHFL does manage to stitch together funds and pay the Rs. 960 Crores owed, AMC’s will be allowed to mark up the paper and the NAV will spike again. However, regulations don’t allow them to mark up a marked down paper before 3 months of the mark down date, and so the upswing (if at all) will take place by early September.

In a nutshell: investors in these funds should not panic and exit in a hurry, as that would be akin to bolting the door after the horse has fled. Stay put and see how events play out over the next week or so, before taking a call. Since the mark down has already taken place, it can’t get any worse. However, things could potentially recover, so those are odds you should be playing. If you’ve got STP’s running from any of the heavily affected debt funds, you may want to pause them for a few months and play the wait and watch game until September.