DHFL Crisis: How to handle your debt mutual funds now?

Last Updated on December 29, 2021 at 4:49 pm

As you know by now, DHFL has failed to pay interest on its bonds in time and the NAV of several debt funds fell sharply (and that is an understatement for some!) on Tuesday night. If you are affected, here is what you should do. If you are not affected, here is how you can lower risk to your capital.

The inability to pay interest on time was called a delay by the company and default by others. On 5th June 2019, Crisil and ICRA downgraded the bonds to Default category. Most mutual funds holding these bonds had marked down the holding by 75% (since they were secured else it would have 100%). Few more funds are expected to markdown NAV on 5th.

Meanwhile, the company issued this statement in response.

The action by the rating agencies is extremely surprising as the Company has been making & continues to make substantial efforts in ensuring no defaults on any bonds, repayment of its financial obligations.
These actions are unwarranted and the Company is seeking clarification on the rationale that predicts DHFL’s inability to service pay‐outs on the due dates. Such a speculative rating rationale is not adequate.
Since September 2018, DHFL has repaid close to Rs. 40,000 crores of financial obligation. To ensure adequate liquidity to meet the repayments, DHFL also sold its strategic retail assets including Aadhar, Avanse and DHFL Pramerica Asset Managers. The Company is committed towards ensuring repayment of all its obligations as well as onboarding the strategic partner for its business.

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So in the next few days, it will become clear if DHFL will be able to pay interest or not. Even if they pull that off, what about the next interest schedule? Readers must be aware that as mentioned in the statement, this situation is not new. Their shares dropped 42% on bond default fears in Sep 2018 and their chairman, Kapil Wadhawan, said

“DHFL has neither defaulted on any bonds or repayment, nor has there been any single instance of a delay on any of its repayment liabilities,

And now we know!

The writing seems to be on the wall for the company. They cannot meet their obligations unless continue liquidating their assets. Unfortunately, mutual funds have now found themselves in a position where they will have to wait.

Every time this happens, the lack of depth in the debt market becomes clear. If a bond drops in rating or credibility it becomes untouchable. So as investors start pulling out at the first sign of trouble, the exposure to the bad bonds keeps increasing and when the s*** hits the fan, fall in NAV is huge as the fund manager is not able to sell. This fund has about 15% of DHFL while the limit is only 10%. Unfortunately, the limit can be maintained only if the AUM is steady (it is only 184 Cr now)

However, this is not universally true. UTI Short Term Income Fund with 4220 Crores fell by 9.43% as it holds about 8.4% of DHFL. If a fund manager cannot offload about 355 Crores of debt before it defaulted in the last 8 months, I do not know what to say. Is the debt market really that bad or has UTI (and other AMC in a similar position) acted irresponsibly?

With each passing day, it has become more and more difficult to recommend debt mutual funds. I am walking on a wire with my Handpicked Mutual Funds April 2019 (PlumbLine)!

Are your debt funds affected by the DHFL Crisis?

Wait for a few days to check if DHFL can pay back the interest. They probably might be able to pull off this interest installment. Even if they do, the NAV will not fully recover and they will be a loss.

In situations where the fall has been large, AMCs are likely to enable side-pocketing. That is the good portion of the portfolio will be segregated from the bad. You can pull out of the good portfolio and wait for the bad portfolio to be sorted out or pull out altogether.

Meanwhile CNBC TV18 tweets:

|DHFL gets RBI’s approval for sale of Avanse Fin to Warburg Pincus; DHFL says divestment of stake in Avanse Fin expected to be completed shortly

So wait a few days for developments and then pull out. Your returns will anyway be affected as shown in yesterdays video