'Never waste a good crisis', goes the saying, generally attributed to Winston Churchill during the Second World War. The sense of this statement is that when there is a crisis, one can make big changes and take measures that would otherwise have heavy constraints or opposition. All kinds of regulatory environments are natural candidates for such actions. Over the last 30 years, major reforms and stricter regulations in the Indian investment landscape have often been responses to significant alarming events in the domain.
For example, the 1992 scam was the event that precipitated the modernisation and the cleaning up of the stock-exchange system and the subsequent establishment of the National Stock Exchange.
However, there is a negative side to this business of never wasting a good crisis. The negative side is that if aspects of the investment markets do not have a crisis and are generally not crisis-prone, then problems in those areas do not get addressed adequately. India's debt funds are such an area. There has been a lot of improvement in the way debt funds are run. However, by and large, given the scale of debt funds' asset base, problems are few and far between. For example, in debt funds, there is simply no counterpart to the banks' NPA problem despite debt funds having functioned as quasi-loan givers in actual operations. This is testimony to the quality of both the regulatory oversight as well as fund management.
However, all smooth roads have bumps. For the last 14 months, there has been an unprecedented crisis in India's debt funds, centred around six funds run by Franklin Templeton Mutual Fund. That's probably not news to any investor. The impact on the reputation of the AMC, and to some extent on all Indian debt funds, has been severe. In fact, conversations with those who are only casually informed about mutual funds reveal that the general trustworthiness of the very concept of mutual fund investing has taken a hit.
On this page, I won't talk about the Franklin affair directly. However, I'll enumerate something that will actually prove to be far more important in the long run than liquidity problems in a handful of funds - which are the reform measures that have happened in response to the crisis.
Let's take a look at all the things that have changed, along with the impact they should have. Listing of wound-up units on stock exchanges: liquidity channel for funds that are in the process of closing down. Fine-tuned risk-o-meter: The revamped risk meter is based on the actual portfolio of schemes, rather than the idealised intention. Minimum 10 percent exposure to liquid assets in each fund: self-evident. Fortnightly disclosure of portfolio: better awareness for investors and analysts. YTM disclosure of bonds held: provide investors with an alternate measure of deliverable value. Risk-class matrix: a matrix that cross-references funds' credit risk with maturity, allowing a better visibility into the nature of the portfolio and the real risks. It encompasses both the investor horizon and the risk level. Incidentally, this is similar to Value Research's own 'style box' matrix that we've been creating for decades. All in all, I'd say that one can justifiably say that the crisis has not gone to waste.
However, I would say that investors should read between the lines of what these measures are actually saying. The message of these measures is that the crisis that debt funds face is as much of investors' making as the AMC's. Some measures are indeed things that the AMCs are supposed to do from now on. However, others are essentially about more information that is being supplied to investors. Think of the new YTM or the matrix rules. What use will these be if investors do not use them? The AMC will just put out this information but it's up to us to use it to make better investment decisions.
It has been my strongly-held belief that the entire debt-fund crisis (even the events that happened long before COVID and Franklin) are the result of investors focusing only on returns. At the end of the day, it's our money and we must use the tools at our disposal.
This editorial appeared in Mutual Fund Insight July 2021 issue. To read the cover story and other insightful analyses, columns and articles