Vodafone’s impact on your debt funds – What now?

For those of you who did not follow us 2 months ago – we not only gave a timely caution but also gave exit strategies based on the exposure that you had to funds that held the Vodafone paper. You can read it here to get a background of the entire issue. We gave the call as soon as the downgrade happened, although the paper remained investment grade at that point.

In essence, we had given a ‘exit’ call on funds that had higher exposure to the Vodafone paper or if you held a higher proportion to a fund exposed to the Vodafone paper.

Now, in the current scenario, if you are still holding the funds that had exposure, what should your strategy be?

In this article – I am torn between the recent feedback received from a small but discerning number of investors, who want us to ‘substantiate’ every single thing we say (fair point, not arguing) and another larger (much larger in our collective experience) set of investors who simply tell us, ‘don’t write an essay, just tell me what I should be doing’. I have tried to satisfy both kinds and hence please bear with the word count or go to the last section directly!

Recent facts

The data first. Here is the list of open-ended funds with exposure to the Vodafone Idea Limited (Vodafone) paper.

Post the Supreme Court’s dismissal of Vodafone’s petition over dues to the government, all Franklin India funds took a mark down of their remaining value in Vodafone’s debt. In other words, the paper was fully written off. All other fund houses appear to have taken a mark-to-market based on credit rating agency valuations. Hence you will see that the exposure and the NAV fall are not the same for the other funds.

Open-ended debt and hybrid funds with Vodafone Idea unsecured NCDs

Scheme Name Exposure % NAV fall %
UTI Credit Risk Fund 17.55 -10.42
UTI Bond Fund 8.32 -4.15
Nippon India Hybrid Bond Fund 7.42 -3.83
Franklin India Low Duration Fund 6.32 -6.87
UTI Regular Savings Fund 5.57 -2.7
Franklin India Income Opportunities Fund 4.92 -5.14
Franklin India Credit Risk Fund 4.67 -4.91
Franklin India STIP 4.32 -4.56
Franklin India Ultra Short Bond Fund 4.27 -4.36
Franklin India Dynamic Accrual Fund 4.08 -4.28
Aditya Birla Sun Life Regular Savings Fund 3.77 -1.2
UTI Dynamic Bond Fund 3.76 -1.89
Aditya Birla Sun Life Equity Hybrid 95 Fund 3.29 -1.03
UTI Medium Term Fund 1.46 -0.71
Aditya Birla Sun Life Medium Term Plan 1.39 -0.47
Nippon India Credit Risk Fund 1.16 -0.36
Aditya Birla Sun Life Short Term Fund 1.08 -0.37
Nippon India Strategic Debt Fund 0.7 -0.24

NAV fall on Jan 16, 2020 for Franklin funds and Jan 17, 2020 for other funds

Multi-layered complexities in deciding

Before we get into what you can do, you need to understand the complexity of taking a decision on holding or exiting funds when the NAV is hit.

Let me list the deciding factors that is under your control (not ours):

  1. When you entered the fund matters. For example: If you had held Franklin India Ultra Short Bond fund for 5 years or more, your return would still be over 8% annualized (after the NAV hit!). Now, should you even bother about the fall, since this return beats any other fixed-income option? (Then why did we give a call in November then? Simply because you could have locked into higher returns at that time). For those who just entered a month or 3 months ago, the same fund is unlikely to beat FD returns if you hold it for just a year.
  2. Your time frame of investing decides everything: An investor had a query whether he would be able to recover his money in a year’s time as he had invested in the Franklin Ultra Short fund only last week. My answer – unlikely. My answer to the same fund, for a 2-year time frame – yes, a high probability ceteris paribus (yield, interest rate, AUM, inflows and so on remaining in similar trajectory)
  3. Your exit load and tax rate: The exit load you pay, and whether you have a short-term or long-term capital gain or loss if you exit now has a bearing on your net returns, and therefore on your decision. Ideally, exit loads should not stop you from getting out of a fund where your risk is greater if you continued to remain invested.
  4. Your exposure to the fund: You will be little hurt if your portfolio has a less than 10% exposure to a fund whose NAV is hit by 10%; as opposed to your holding 30% in a fund whose NAV fell 10%.

The above is complex and needs to be looked at as a whole – but it can be deciphered.

High yields may not transpire into returns

Scheme Name Avg. maturity (Dec-19) Dec 2019 (YTM)
Aditya Birla Sun Life Medium Term Plan 3.8 16.08
Aditya Birla Sun Life Short Term Fund 2.49 8.57
Franklin India Credit Risk Fund 2.77 12.64
Franklin India Dynamic Accrual Fund 2.47 12.54
Franklin India Income Opportunities Fund 3.97 12.48
Franklin India Low Duration Fund 1.24 12.34
Franklin India STIP 2.47 13.01
Franklin India Ultra Short Bond Fund 0.59 10.37
Nippon India Credit Risk Fund 2.56 13.75
Nippon India Strategic Debt Fund 3.84 13.62
UTI Bond Fund 4.85 10.25
UTI Credit Risk Fund 1.18 15.85
UTI Dynamic Bond Fund 4.64 8.69
UTI Medium Term Fund 1.82 10.43

For open-ended debt funds that held Vodafone paper; not including hybrid options.

But there are lot more moving parts to giving a logical call after such events transpire. When there are fewer variables, it is possible to build a mathematical probability that will hold. But when there are way too many variables, unless most of them remain unchanged, our call can go entirely wrong. Here are just some of them.

  1. Redemption pressure: Often, a fund’s exposure to a bad paper may be low but panic may result in redemption pressure and lower AUM. As a result, exposure to the same paper swells. In the first table above on exposure to the Vodafone paper, you can see that in the Franklin funds, the write off is more than the exposure as of December. That means between December and now, these funds saw some erosion in their AUM. Not only that, there can be sub-optimal selling by the fund house causing rapid change in the portfolio yields.
  2. Yields can mislead: Sometimes, when a call to hold to a fund is taken, it is done merely by a theoretical calculation of yield over the residual duration of the portfolio less expense ratio. The yields can be inflated, either because there was a sell-off in select papers (causing yields to rise) or due to market aversion to credit risk. Unless the credit issues are resolved, such yields may not necessarily transpire into returns. (How do you identify whether the yields are misleading or really come from taking high coupon papers that may click? That is to be a separate article, some other day, for our premium investors 😊)
  3. Adjusting yields: As an outsider without up-to-date data on every aspect of the portfolio or the knowhow, it may be hard to adjust the yield of a bad paper. The coupon of every paper, the residual maturity and the papers’ weight must be considered to arrive at the new yields. Portfolios often have instruments like ZCBs or floating rate bonds and unless one knows the time of entry or the changing rate, it may be hard to even forecast the return  from this point that an investor can expect if he/she holds the paper.
  4. Interest rate cycles: The yield of a portfolio may rapidly change if the interest rate cycle is turning and this may entirely turn the table on the decision to hold or sell.
  5. Inflows: Significant inflows in depressed NAV funds is not a rarity. When that happens, more investments at lower yields (in a falling rate scenario) or vice versa may prove a hold or sell decision wrong.

After all this….

Now, if your question is, what does this mean to me, we can guide you to make a decision. Know these first:

  1. All the Franklin funds have marked down fully but the others have not. So the latter can go south further in case of any adverse rating agency action or a default or in the remote event of the company going into liquidation.
  2. The next earliest maturity for Vodafone papers (for mutual funds) will be July 2020. All six Franklin funds hold this paper (plus papers maturing later). The other fund to hold July maturity is UTI Credit Risk. Among these, Franklin India Ultra Short Bond has only one Vodafone paper, and that matures in July 2020. Hence, if the issue resolves or the money is repaid, the earliest to recover fully would be Franklin India Ultra Short bond. Before you rejoice, please assume that you would not get back the money. This will help you assess what you should do without making assumptions on probability of repayment.

Returns of open-ended funds after the hit on Jan 16/17 2020

Scheme Name 1 Month 3 Months 6 Months 1 Year 2 Years 3 Years 5 Years
Aditya Birla Sun Life Medium Term Plan 0.4 -6.1 -6.7 0.2 2.2 5.4 5.5
Aditya Birla Sun Life Short Term Fund 0.4 1 2.9 7.4 6.6 7.8 7.9
Franklin India Credit Risk Fund -3.8 -3.7 -3.4 -1 3.7 5 6.6
Franklin India Dynamic Accrual Fund -3.2 -2.8 -1.9 1.8 5.2 6.1 7.6
Franklin India Income Opportunities Fund -3.9 -3.8 -3.5 0 4 5.4 6.7
Franklin India Low Duration Fund -6 -6.9 -5.4 -2 3.2 4.8 6.7
Franklin India STIP -3.6 -4.1 -3.7 -0.5 4.2 5.5 6.7
Franklin India Ultra Short Bond Fund -3.6 -2.2 0 4.6 6.8 7.2 8.2
Nippon India Credit Risk Fund 0.3 0.5 1.2 1.4 3.8 4.7 6.6
Nippon India Strategic Debt Fund 0.4 -0.4 -0.3 -3.8 0.4 2.3 5.3
UTI Bond Fund -3.3 -3.6 -5.2 -9.5 -3.1 -1.2 3
UTI Credit Risk Fund -9.8 -9.4 -14.3 -14.6 -5 -1.4 2.9
UTI Dynamic Bond Fund -1.2 -0.9 -1.6 -5.4 -0.4 0.8 4.6
UTI Medium Term Fund -0.1 0.4 2 5.2 5.4 5.7 --
Aditya Birla Sun Life Equity Hybrid 95 Fund 1.7 4.5 3.4 6.1 0.2 7 6.8
Aditya Birla Sun Life Regular Savings Fund 0.5 1.3 1.7 5.9 1.6 5.1 6.9
Nippon India Hybrid Bond Fund -2.9 -2.2 -1.9 -1 1.4 3.7 5.2
UTI Regular Savings Fund -0.9 0.2 -0.1 0.9 2 5.1 6.2

Here’s what action you can take, depending on your situation:

  1. If you who have held the funds for 3-5 years or more: You can afford to wait, except in the following funds: UTI Credit Risk, UTI Bond and Nippon India Hybrid Bond as they have high exposure to Vodafone and haven’t written it off fully. Hence, exit those. They have also taken other hits. Exit funds with a stated credit strategy as there could be more risks looming there. Use our review tool for the hybrid funds.
  2. If you have held these funds for 1-3 years: it is a bit tricky. You will need to hold the funds for another 2-3 years for returns to normalize (reach 7% or more). Those of you in losses, exit and consider setting it off against any profits. Others, decide whether you can hold for another 2-3 years (other than credit risk funds and the funds mentioned as exit in point 1). Else, exit and reinvest in other low risk debt funds.
  3. If you entered in the last 1 year and have a time frame of one year or less (especially in ultra-short or low duration funds). This situation poses problems. You may need to hold them for 1.5-2 years to ensure that you get what you initially expected. So if your holding timeframe aligns with the funds’ current maturity, then you are unlikely to beat FD returns. You may therefore need to exit and reinvest in an FD. If you have the luxury of keeping this money aside for longer, do so (again, this does not include the funds given as exit in point 1).
  4. The guide above is given in the scenario that the money is not repaid and that the rest of the portfolio returns will make it up for you, in time.

If you knowingly invested in credit risk funds and this NAV fall has troubled you even if you have a long timeframe, credit risk funds don’t suit you. When you can, move to lower-risk accrual funds.

And finally – if Vodafone’s situation does resolve and funds receive all payments, please do not come back to us saying that you lost an opportunity or you made losses by selling the fund. The decision you make today is to cut losses, and because your situation does not allow you to take chances with your money. Never look back!! It is so for equities and doubly so for debt.

If you are looking for alternatives, look at our Prime Funds. You may be surprised by some of our choices there. Feel free to write to us then, as subscribers! Also use our review tool as a hygiene. Whether you decide to hold funds to make up losses or not, our review tool will tell you whether you are with good funds in the first place.

24 thoughts on “Vodafone’s impact on your debt funds – What now?”

  1. Suhas B

    Very well written, i fall in the ‘substantiate every single thing’ category, few suggestions,
    a) these standard categorization of ‘ultra short’ ‘short’ ‘low duration’ are all misnomer(according to me), i would suggest based on your experience to categorize funds as simple “debt funds-low risk” “debt funds-med risk” “debt funds-high risk” etc.
    b) Apart from ‘start rating’ the funds it would be better to suggest the holding period for those funds according to your experience

    1. Vidya Bala

      Suhas, thanks!
      So, it looks like you haven’t seen our Prime funds yet 🙂 We have what you mentioned, there.
      1. They are SEBI’s categories not ours. We have to necessarily use them in public for commonality in expression. We use our own bucketing while assessing funds. Read about it here: https://www.primeinvestor.in/2019/12/03/primeinvestor-ratings-how-we-rate-funds-and-why-were-different/

      2. Based on risk and based on time frame – our Prime funds (our research recommended funds not ratings) have that. Our rating is not a recommendation tool. It is a performance assessment tools vis-q-vis peers.

      thanks, Vidya

  2. Palanisamy M

    In last November you have red flagged Vodafone issue. But still You had recommended FT ultra short term bond fund with 4.5 ratings and still it carries same rating. Does this means can the fresh investment be made in that fund??

  3. Murali Krishnamurthy

    Great article. Every novice investor should read this.

    Debt funds are a lot more riskier than equity due to lack of transparency. Exposure of >3% in such bonds will cause capital loss. Fortunately this Vodafone issue was in news for last couple of months and I just withdrew all my allocation from this FT fund and avoided loss.
    Someone parking money for a few months in this fund will definitely have to exit with loss.

    All FT debt funds provide better returns over the peers but they have higher risk due to defaults like these.
    NAV keeps dropping due to defaults if one observes the graph. But due to smaller allocation, people do not realise.
    There are better options which may give 1% less returns than FT funds, but much safer.
    People should opt for those always.

    Thanks to Primefund list which has some decent options for investors to bank on.

  4. Mehul Sangani

    Thanks for the article.
    I have invested in ABSL medium term plan.
    Now if i understand correctly, Vodafone idea papaers make up 1.39 % of fund’s portfolio.. So, does it mean that out of the total value of my investment in this fund, 1.39% is in Vodafone? Is it likely that this share may get side pocketted? and thereby, i ll practically lose this amount for ever?/

    1. Vidya Bala

      Hello Mehul, If the loan is not repaid or goes to default, ABSL may choose to side pocket it. That does not mean you won’t get it. It simply means it is segregated and when the money is repaid in part or full, you will get it. But please note ABSL already has taken many hits and may see some recovery in its IL&FS toll road exposure. thanks, Vidya

  5. Amit Mukherjee

    Article is well written and informative. Thanks for your suggestive views.
    I invested 3L almost 10 months back. Should I come out as from 3.20 L now it is 3.07 L.
    I am @70. Hence need your advise.
    Regards
    Amit Mukherjee

    1. Vidya Bala

      Sir, Thank you for writing to us. I understand your concern. As stated in the article, if you do not have any pressing need for the money, you can wait for the time frames we have mentioned for those who bought in the last 1 year. You have not mentioned which funds. Either which way, we are contrained from providing our views on the blog in any advisory capacity. Kindly subscribe to use our review tool and our recommended list of funds.
      thanks, Vidya

  6. Vishal Sarda

    The interesting poser now is –
    a) If Voda gets moratorium for AGR dues and consequently there is no rating downgrade from the rating agencies, does FT mark up the NAVs?
    b) If there’s no concession and Voda defaults, followed by ratings downgrade, does FT side-pocket the affected units, thereby releasing the rest of the funds?
    c) Voda gets a moratorium, there’s no rating downgrade, however, FT continues to keep the papers marked down to zero.

    It’s prisoner’s dilemma as far as FT is concerned. In the first two options, invariably redemptions will follow, thereby reducing the AUM swiftly and consequently increasing Voda exposure as a percentage of portfolio. If FT follows the 3rd course of action (which seems likely, given their body language) short term investors are stuck till July in Ultra Short Bond, thereby investor’s lose precious liquidity. Net net, I would find it hard to trust FT again.

    1. Vidya Bala

      Hi Vishal,
      Thank you for penning your views. The dilemma is for UTI and ABSL and Nippon (quite a bit in FMP) and not just FT.
      a. THe prices of the instruments have gone down (valuation by rating agencies that UTI and Nippon and ABSL have followed) without any downgrade. So if FT decides to mark it up, it cannot be higher than the valuation price.
      b. Yes, it is at the discretion of FT or for that matter other MFs.Others though will have to write don entirely after such an event.
      c. Quite plausible.
      FT Ultra short bond – has always been a misfit in ultra short category. It shouldn’t be there given the credit risk profile.
      thanks
      Vidya

  7. Suman Kumar Ray

    Excellent article. Very informative. Btw, as FT has marked down full exposure to Vodafone Idea on affected funds, does it mean new investor on these FT fund will not see any negative impact due to these current Vodafone debt?
    Secondly I don’t understand the scope of sidepocketing in future when asset has been already marked down to zero. Does it mean, if sidepocketing happens in future due to downgrade, it will not impact NAV that time, since asset has already been marked down to zero?

    1. Vidya Bala

      Hi,
      Thanks. Yes, new investors will not take any further hits on Vodafone. But given that the fund is high on credit risk, fresh hits on other instruments can never be ruled out 🙂 Your understanding is right. NAV will not be impacted when sidepocketed, yes. But you have also raised an interesting scenario: ideally, the fund house should not sidepocket, since it does not benefit the existing investors by sidepocketing (if new investors – who may be coming in now – also get segregated units…the purpose of sidepocketing will be lost).
      thanks, Vidya

  8. SANJAY KUMAR

    Very Nice article.

    Is it right to say that FT Ultra short bond has already taken hit in NAV of vodafone default ? So for new investor it is right time to get into this fund, as going forward there could be two events, either vodafone repays back in july’20 then there is every possibility to markup in NAV or else no impact on NAV as the hit was already considered.

    Your view please.

    1. Vidya Bala

      Hello Sir, sorry for the delay in responding. Your point is true except that the fund per se carries high credit risk. So another such event transpiring is always a possibility. If youa re a subscriber, please check what we say about this fund in our PRime funds list and our review tool. Thanks, Vidya

  9. Sreenath Y V

    Hi, How about FT Liquid Fund? Thanks to your timely notification on Ultra Short Term Bond Fund, I could exit before FT has written off Vodafone paper. I appreciate you guys for giving subscribers an early warning. How safe is FT Liquid Fund? Thank you. I had been investing in debt, liquid funds for close to 2 decades and I fail to fully understand this class of funds vis-a-vis equity. Would be grateful if you could write an article on some basics. Given that nowadays debt funds are no less riskier than equity, a fair level of understanding of debt funds is very critical. I still cannot forget the advice Srikanth Meenakshi gave me 10 years ago against investing in P-Notes fund offered by Citibank. It is only recently that I could understand a bit, thanks to social media. Thankfully, I took Srikanth’s advice and stayed away!

  10. SUNDARESAN SUBRAMANIAM

    Madam,
    Thanks for your immediate response for my mail today morning. Meanwhile I would like to take your advice on my mutual funds holdings. My funds have been reviewed and recommendations have been given. Some of them have been given buy call with 4-5 star ratings. Some of the funds (especially liquid funds ) have been given ‘hold’ ratings. I like to know whether I can dispose these funds and go for top rated funds from prime ratings. Is it correct. Pl.advice me .
    Thanks
    sundaresan.s

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