Edit: We have updated the post with a few corrections.
Ballarpur Industries shocked investors in Taurus Mutual Fund on Wednesday. The relatively “safe” versions of their debt funds lost a truckload of money in terms of an NAV drop, from 7% to nearly 12%.
What happened was:
- Ballarpur has been having a problem repaying debt.
- Taurus mutual fund has held Ballarpur debt as commercial paper, in its liquid and short term debt funds
- Taurus has very low AUM, so the relative weight of Ballarpur has been high
- Ballarpur got downgraded to a “default” rating by IndiaRatings (see link) which meant that the bonds had to be marked down.
- And that marking down has resulted in a big fall in the NAV.
Wait! How Can The Fund Fall More Than The Holding of Ballarpur?
As you can see, the Liquid fund held just 4.32% of Ballarpur but fell 7%. Even if they marked the full holding to zero, the max they should have lost is 4.32%?
Correction: In the following paragraph, the implication was not that the fund managers or the AMC knew of the default in advance, but that some investors in the fund knew. We have corrected it accordingly
Welcome to the murky world of funds. They needn’t have marked it down to zero till yesterday. But obviously some investors knew of the default potential. So it’s quite likely that people withdrew money earlier, at a relatively higher NAV (or, when Taurus’ NAV had some value for the Ballarpur holding). As they exited, the funds had to sell the remaining stuff they had (because obviously no one is buying any of the Ballarpur bonds – people in Fixed Income are super-smart).
As a result, the funds’ AUM would fall, and because they continue to hold the Ballarpur holding in the same quantity, the relative size of Ballarpur would keep increasing, even from Jan 31 to yesterday. (Feb 22)
And it seems like yesterday the holdings of Ballarpur as a percentage of AUM were higher than the portfolio on Jan 31. It’s likely to have been because other investors exited.
The Rolling CP: Taurus kept rolling into Ballarpur Short Term Debt
Ballarpur issued commercial paper (short term paper) and has been consistently rolling it – meaning, when it expires, issue new paper and so on. And the roll periods were 1 month (so issue for a month, then at the end of the month issue new paper for another month etc).
This is not illegal, and in fact this is how the government runs. But the government has nearly no risk of default (of eventually being able to pay).
Ballarpur however had to face a day of reckoning some day. The roll periods fell to 2 weeks – Probably because lenders didn’t want longer term exposure, and there was potentially a settlement of sorts hanging in the air.
Look at the paper held by the funds on Jan 31:
They all matured within a few days (and new CP would have been issued on the 7th, 13th and 14th).
Now, with the downgrade, they can still issue new CP, but a buyer (a mutual fund, bank or insurer) would demand a higher interest rate and still have to keep the valuation very low.
Correction: Apparently RBI doesn’t allow CP that’s rated below A3 (Ballarpur is A4) so they can’t issue new CP. Any new funding will have to come from banks or a lending institution, which will still demand a high interest rate.
If Ballarpur can’t really pay now, they won’t be able to pay an even higher interest rate – so there will be a hit of some sort anyhow.
What’s The Lesson?
This is about size. Taurus was too small a mutual fund at this time (except perhaps the liquid fund!) so even a single lot of a CP – typically 5 cr. in value – was a huge percentage of the fund size.
Secondly because of high concentration, the credit risk became crazy. That means a single default would hit the fund hard, simply because it cannot diversify. (If you have only 60 cr. in AUM, even one lot of ANYTHING would be nearly 10% of your fund).
Some other funds have huge concentration – like Birla SL Dynamic Bond fund has over 40% in one government bond. There’s no real credit risk there (government bonds have near zero risk of default) but the interest rate risk and market risk for that bond is very high, so the fund’s fortunes are based pretty much on that bond’s move alone.
A key problem is that the Liquid fund has lost a lot of money. With over 1600 cr. in AUM on Jan 31, it’s managed to lose 7%, something that’s scary for any liquid fund owner. Plus the rolling CP means that you don’t even know when shorter term exposure to one company is increasing dramatically. This does mean that fund houses with large exposure to one company (as a whole) may not be able to exit in time, unless the AMC itself does something to redeem itself.
The Ballarpur story may still work well – if there’s a good settlement some of this money may come back. But it will take time, and it’s unlikely that all of the losses will come back – if 50% of the Ballarpur money returns, that would still be good. If you’re an investor in these funds, unfortunately, I can only say wait for clarity if you can; it will probably take another three to six months to resolve and recover a part of your losses.
Update: A Quick Statement
There has been a lot of questions about things here. Do consider that:
- Ballarpur is not a wilful default, this is a company that was stretched. A haircut was expected in any case.
- What’s happened is a “100% haircut” where the funds were marked down to zero. I will explain in another post why this is fair to unitholders given the circumstances.
- Taurus has not stopped redemptions. If you hold the funds, you can still redeem.
- But it makes no sense to redeem. Because at some point, Ballarpur is expected to pay something – the assets are worth some money and that will be realized – if not now, then later. When that money comes, what is marked down to zero will be marked up, resulting in a RISE in NAV at that date.
- There is no reason to assume any hanky panky at the fund. Ballarpur’s problems were well known. Their CP rating was A1+ till July 2016 when it was downgraded to A1 (which is still decent) and then to A3 (which is BBB-, or a serious risk of default) only in December 2016.
- However corporate players would have known about the impending issues – a Joint Lender’s Forum meet on Feb 13 etc. after which there was a likely downgrade and so on. They would have yanked off funds early if they were invested in such funds.
- Reliable sources have confirmed that Ballarpur has repaid money all through the last 1 year or so, repaying about Rs. 40 cr. in this time. There is a good chance that some of the “written off” money will return.
- Taurus as a whole only owned about 100 cr. of Ballarpur’s debt – and Ballarpur has over 7,000 cr. of borrowing (consolidated). Taurus isn’t the only one to be hit – but the rest are hiding the impact for now. (Even other mutual funds had exposure but managed to get away with it by selling bonds to entities who may not necessarily be independent)
- You should not consider investments in liquid funds as risk free, or in any debt fund as such. There will be more such times, and you may have to keep your money in such funds for longer periods of time while a recovery happens, even if partially. The concept of a 100% write down though needs addressing at a systematic level. (We’ll cover this separately)