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Mutual Funds

Ballarpur Downgraded To Default, and Taurus Debt Funds Get Whacked


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.

Mutual Fund holdings in BallarpurThe NAV and holding is as of Jan 31, 2017.
Correction: Taurus Liquid Fund held about 4.32% in Ballarpur. Our apologies.

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:
Ballarpur Bonds and CP
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)
  • Jay says:

    Deepak, thanks for the timely article. Should investors not trust the fund managers and keep looking closely at the portfolio and follow every ifs and buts of the decisions made? The whole purpose of fund manager and fund management fee is lost in that case. These are supposed to be stable type (ultra short term for God’s sake!!) of funds and not the Gilt or Dynamic category and still the investor has to face the brunt. Is there no mechanism that the AMC is held responsible for the losses ?

    • There isn’t one explicitly. People assume that the AMC won’t let the investos lose. Taurus is a smaller fund house so can’t bear a loss this big. But some others may.
      You’re right in that we shouldn’t have to check portfolios etc. BUt what to do when it’s not easy to find out why a fund lost so much money etc…

  • Sanjay Singhaniya says:

    Hi Deepak,
    I had invested in Taurus Short term income fund which has lost 11.33% today. I don’t need money urgently. So what is your advice? Should I wait for three to six months in the hope of partial recovery of losses?
    Also, how to find when a debt mutual fund is taking too much risk? ValueResearchOnline has given 4 stars to this fund.
    I am retail investor with my investment in this fund is less than 3 lacs but a considerable sum of money for me. Is there a chance of more losses in the same fund via some more companies in the portfolio defaulting?

  • Swami says:

    Unfortunate owner of both Taurus Ultra Short term and Short term funds here! Invested a lot in these funds as it these were identified as “high quality, low interest rate sensitivity” and rated 5 stars in almost all MF review websites. None of these sites had warned about any concentration risk. I can understand if I lose money in other equity or long term debt funds that provide better returns but these funds that return only about 8% and considered so safe lose so much NAV in a day??? This only leads to total drop of confidence in entire set of MF houses. Now a wait of 3-6 months seems to be too long. One question though – is there any possibility of further drop in NAVs in these two funds (Taurus Ultra short term and Short term)? Thank you.

    • Do not exit please. You will benefit when the money from ballarpur comes (even if it’s a smaller portion of the money they have borrowed).
      Also, VR ratings are not to be relied upon. In fact no one knew about the risk in the liquid fund, but the rest, which are limited by size will have to have concentration risk.
      There doesn’t seem to be a big risk of a further fall in NAVs.

      • Swami says:

        Thank you very much for taking the time to respond and to update the article with the latest news. Much appreciated as there is no other source of information on this – ICICI Direct is yet to realize that something has gone wrong in these funds!Will wait and not exit the funds now with the hope that Taurus is able to get some money back from BILT. Thanks again Mr. Deepak Shenoy.

  • Ashok says:

    Lessons: Better to stick with the bigger fund houses like HDFC, ICICI Pru, or BSL. Even then invest only in debt funds which have more than 5000cr AUM.

  • Bhaskar says:

    What i don’t understand is Ballarpur is a listed company with its financial being available and everyone knew it had debt issues, why did these MFs hang on to their investments? All other paper stocks have been doing well in the last few quarters because of Ballarpur. Better to invest in old fashioned fixed deposits, at least the returns are fixed. Take risk in equity part of your portfolio.

    • Well, you can’t exit an investment no one wants to buy…debt investments are illiquid.
      Other mutual funds seem to have sold to their parents who are holding the debt and hoping the default won’t be big.
      Such things happen once in a while. It’s not often you see this happen with a liquid fund of course.

  • Debi prasad sarkar says:

    I was also an unfortunate holder of taurus ultra short term bond fund & on the day of the catastrophe i could not beleive my eyes that an ultra short term bond fund NAV fall by 11% in a single day?Then what is the need of ratings by VR & all.If risk is so much then why investing in a ultra short term debt fund?The AMC concerned can not wash its hand off from the responsibility for plundering wealth of innocent customers.Is SEBI monitoring this?