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Wild NAV Movements

The reason behind sharp spurts in Escorts Income Bond's NAV is the late provisioning of unrecoverable assets. Investors who exited before provisioning benefited and the rest have suffered. Does this defy the basic structure of a mutual fund.

When your bond fund, which is expected to give steady returns, suddenly outpaces all its peers and equity markets as well, it has to be too good to be true. This is what has happened with Escorts Income Bond. The scheme has delivered an astounding 44.69 per cent in the September quarter of 2002 and 102.60 per cent in one year ending January 16, 2002. More specifically, the scheme's NAV has jumped up by 31 per cent on a single day in September. This could possibly make it the best bond fund in the world.

However, a look at the fund's history shows that these 'spurts' in NAV have not been a one way movement. There have been periods when the NAV has crumbled just as suddenly as it has shot up. Throughout 2001 the fund has lost between 16 and 33 per cent on different occasions.

A look at history shows that Escorts Income Bond was launched as a close end fund in October '96. It was converted to an open ended scheme in November '01. During the period in which the scheme was close-ended, repurchase was allowed in intervals of 6 months. The scheme had been providing healthy returns till 2000. In 2001 it, however, registered a decline of 66.5 per cent. A look at the scheme's portfolio disclosure shows that some of its investments went bad. Specifically the fund had invested in debt instruments of Precision Fasteners (Rs 2 crore), JCT Electronics (Rs 1 crore) and Raymond Synthetics (Rs 1crore). These had matured in November '98, November '99 and May '00 respectively. The fund had failed to receive principal and interest from Precision Fastners and JCT Electronics when the investments matured.

In October 2000, Securities and Exchange Board of India (SEBI), released guidelines on Non Performing Assets (NPAs). According to these, once an asset has been declared an NPA, full provisioning for these has to be made in a phased manner. An investment is declared to be non-performing if the interest and or principal amount is not received or remains outstanding for one quarter from the day it has fallen due. In accordance with these guidelines the fund has made provisions for these investments. The effect of this provisioning can be seen from the sharp fall that happened in its NAV in different periods in 2002.

All unit holders who exited the scheme before the provisioning took place benefited. While the value of their investments had fallen, they received the full amount. When these investors left and provisioning was made, its impact was more intense. Investors who remained had to suffer these losses. As all investors in a fund are equal the profit and loss has to be shared equally. This did not happen. The correct course of action would have been to make provisions as soon as it became clear that default had occurred on these investments. And it is the partial recovery of these losses, which has resulted in the return of 44 per cent in September 2002.

What this goes to show is that the lack of timely valuation can distort the basic structure of a mutual fund. And while all unit holders are meant to receive equal treatment under all circumstances, lack of transparency can disturb this equilibrium. It is the trustees of a fund and the regulators have to ensure that this transparency and fair play is maintained at all times.