Many mutual fund investors (and advisors too perhaps) were shocked to learn that JP Morgan AMC decided to limits redemptions to 1% of outstanding units at the end of each business day. Questions and statements like, “how can they do this?!”, “what is SEBI doing?”, “it is my money and I have the right to take it out when I want”, did the rounds. A look at the fine print, the implications of mass redemptions and if JP Morgan AMC was justified in its actions.
Why they did it?
Two of their debt fund schemes, JPMorgan India Treasury Fund and JPMorgan India Short Term Income Fund, collectively held about 400 Crores of Amtek Auto debentures which were downgraded by rating agencies. This led to a sudden fall in NAV. Read more here: Understanding Credit Rating Risk in Debt Mutual Funds
The JPMorgan India Short Term Income Fund was part of Mint 50 and FundsIndias ‘select’ list. While Mint said ‘hold on’, FundsIndia, said ‘exit’. Twitter onlookers were quick to criticise FundsIndia (which is immature) and many financial advisors joined the chorus and sounded as if they would never touch JP Morgan funds!!
So naturally fear spread among investors who wanted to exit the funds in a hurry. Therefore, JP Morgan was forced to use the ‘Right to Limit Redemptions’ rule laid down by SEBI.
Right to Limit Redemptions: The Trustee, in the general interest of the unit holders of the Scheme offered under this Offer Document and keeping in view of the unforeseen circumstances/unusual market conditions, may limit the total number of Units which can be redeemed on any Business Day depending on the total “Saleable Underlying Stock” available with the fund.
Whether it is an “unforeseen circumstances/unusual market conditions” is quite debatable. That JP Morgan chose Amtek bonds is not the problem. That they could not get rid of them when the firm got into trouble is the problem. Who would be willing to buy bonds from a firm with no credibility.
So all investors in those two JPM funds decide to exit together, who will be affected? The AMC or the investors?
In October 2008, when there such a situation, the AMC took the losses in their books. However, SEBI decreed that bonds must be marketed to market. So if all investors exit a mutual funds, the AMC will simply sell holdings at market prices and the investors will bear the loss (the NAV will plummet).
So JP Morgan is right in limiting redemptions to protect investors. JP Morgan made a bad call in selecting Amtek bonds. Something that we can state with the benefit of hindsight. Such calls are part of parcel of security selection and financial advisory. Investor not mature enough to understand this, ought not to use mutual funds.
Let us not forget When we invest, it is “our money”. We give it a custodian who are duty bound to the group of investors. Not just us. When we redeeem, we do not get money. We get units held times current NAV. It is the AMCs prerogative to protect that NAV.
When an AMC limits inflow, it does to protect unitholder interest. Then we hail the AMC as professional and investor friendly. The same applies when the AMC limits outflows due to unusual circumstances.
What happened to JP Morgan can happen to any AMC!
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