Change in FundsIndia’s Select Funds

The Mutual Fund Research Desk at FundsIndia.com conducts a quarterly review of funds in the Select Funds list, and comes up with changes (if any). We’ve just conducted a mid-term review of our list on account of a change in our view of a specific fund.

Our call

We have decided to remove JP Morgan India Short Term Income Fund from our Debt Funds (1-2 years) category in the Select Funds list. This is on account of the fund’s ongoing challenges with one of its instruments, i.e., Care AA- (until early August 2015) rated, secured, Non Convertible Debentures (NCDs that are classified as money market bonds) of the auto ancillary company – Amtek Auto. This NCD is due for maturity on September 20 in the scheme’s books, and this scheme had about Rs. 66 crore of exposure in the company’s debt (as of July 2015). This accounted for 16 per cent of the scheme’s assets.

The fund’s returns dwindled to 6.1 per cent over one year as a result of some turbulence. Recent cash flow crunches faced by Amtek Auto have raised questions about its short-to-medium term debt repayment capacity.

What happened

Amtek Auto is an established auto ancillary company, with its stock listed in the exchanges.
The company took heavy debt to support additional capacities and aggressive inorganic growth plans. However, this backfired, given that its export market too has dipped a bit.

The company caused some ripples in the stock market soon after it announced its quarterly results mid-August, posting a net loss as opposed to profitable quarters earlier, and a year ago as well.

The National Stock Exchange (NSE) also announced the removal of the stock from its Futures & Options (F&O) list effective October 30, 2015, causing the stock to tank. While CARE rating had suspended its AA- rating of the company’s debt instrument in early August, another rating company, Brickworks, downgraded the company on August 27 from A+ in July 2015 to C.

All these events were post our updated and reviewed list in early July 2015. The Net Asset Value (NAV) of JP Morgan India Short Term Income fell 3.38 per cent on August 27; it is likely that this is a marked-to-market loss required by the regulator in case of a downgrade in non traded securities. That means the loss may be temporary, and may be recovered once the maturity amount is received.

Our concern

While we remain concerned about the repayment of this NCD, we are not unduly worried. The company has already got shareholder approval to issue shares to promoters and others to raise fresh money.

It is likely that Amtek Auto will also look at rolling over some of its bonds with other holders (other than JP Morgan), and will also be supported by a line of credit from banks as no bank would be interested in adding this leveraged (but business-wise,a fundamentally sound company that isn’t in bad shape) company to their Non Performing Assets (NPAs) too soon. Also, we understand that JP Morgan AMC has received interest payments due thus far from the company.

However, we are worried on two other counts:

– One, an AA- rating by CARE was suddenly suspended by the rating agency this month.
– Two, another rating agency downgraded this company’s NCDs from A+ to C.

That an investment grade instrument (that too in its ‘As’) was downgraded/suspended suddenly does cause worry about the quality of assessment that is not just restricted to the rating universe. However, that aside, what causes us concern is JP Morgan’s own due diligence mechanism.

When a company in A grade moves multiple notches lower, two things could have gone wrong: one, that it was not an A grade company in the first place; two, it was a solid company to begin with, but a rapid sequence of unforeseeable bad events caused the downgrade. We don’t think the latter is the case since this recent turmoil with the company was due to leverage and acquisitions which don’t happen overnight, and there would have been sufficient forewarnings and red flags about its deteriorating financial condition.

For an otherwise low-risk fund (whose portfolio until recently was dominated by low-risk certificate of deposits) to hold this instrument in its portfolio, the fund management would have had to overlook these series of events, placing investors’ monies at peril. This does not inspire confidence, and forces us to re-evaluate their debt picking process.

Action

Investors holding the fund or running Systematic Investment Plans (SIPs) can exit and move to HDFC Short Term Opportunities Fund, another fund from our list with a higher proportion of AAA-rated instruments in established companies. While this fund too is not devoid of AA instrument holding, its exposure to them, individually and overall, is not high.

We would suggest that you stay invested in debt funds instead of entirely cashing out, as the debt market remains ripe for capital appreciation opportunities. While this event is a reminder that debt is not devoid of risks, we would urge investors not to panic based on these events. We believe debt should be a part of every portfolio, and debt funds are a superior option to traditional instruments in terms of post-tax returns, if one sticks to the recommended time frame for the fund.

The following is an update to the above blog on August 29. 2015:

Notification to unitholders from JP Morgan AMC on August 29, 2015:
JPMorgan Mutual Fund India Private Limited (the trustee company of JPMorgan Mutual Fund) in consultation with the asset management company, JPMorgan Asset Management India Private Limited (JPMAMIPL), has decided to limit the total number of units of JPMorgan India Short Term Income Fund (JPMISTIF) and JPMorgan India Treasury Fund (JPMITF) which may be redeemed and/or switched-out of on any business day to 1% of the total number of units then in issue and outstanding in the said funds/schemes in accordance with the Trust Deed and scheme offering documents, with effect from August 28, 2015. This is a cautionary measure to protect the interests of the investors.
Any units which consequently are not redeemed on a particular business day will, subject to the further application of the trustee company’s right to limit redemption/switch outs, be carried forward for redemption to the next business day.
JPMAMIPL will inform investors in advance should this limitation on redemptions and switch-outs are to be removed.
Mandates for Systematic Transfer Plans (STPs) and Systematic Withdrawal Plans (SWPs) will be subject to this same limitation.

FundsIndia’s Research team has, to the best of its ability, taken into account various factors – both quantitative measures and qualitative assessments, in an unbiased manner, while choosing the fund(s) mentioned above. However, they carry unknown risks and uncertainties linked to broad markets, as well as analysts’ expectations about future events. They should not, therefore, be the sole basis of investment decisions. To know how to read our weekly fund reviews, please click here.