Lessons from the JP Morgan – Amtek Auto Debacle

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Recently, after two of its debt fund schemes suffered a sharp fall in NAV due to acredit rating downgrade of Amtek Auto debentures, JP Morgan AMC limits redemption from two of its schemes. Some lessons from the debacle.

1. Financial advice can go wrong!

Advisors and analysts are human and they can go wrong at any time. At the end of the day, there is a subjective element to fund, stock and bond selection and portfolio management. We as investors must recognise that and not blindly follow their advice. It is our money. No one cares about it as much as we do. Whether the advice is from our distributor, financial advisor or from a magazine, understanding the nature of the product and its suitability is our responsibility.

No one understands your risk appetite and risk profile as you do (risk profiling questionnaires can be woefully inadequate). So researching financial products (even those suggested by a professional) is your job.

If an advisor claims that he/she would never have recommend “such funds”, run away from them.

 

2. What happened at JP Morgan can happen at any AMC!

A good time to remember the advice, “diversify across AMCs”. It is hard for investors to differentiate between ‘good’ and ‘bad’ AMCs.  Perhaps no one is ‘good’!

3. Read Scheme information documents!

Very few investors are aware of the fact that reading scheme information documents is one of the best ways to understand how mutual funds work. Where they invest, and what the risks associated with the investment.

Most investors (like me) cannot analyse the contents of a mutual fund portfolio. If I could, I would be investing in stocks and bonds directly! So I make sure I understand the mandate of the funds that I hold.

4. Stick to liquid and ultra-short term debt funds!

These funds can be part of any debt portfolio for any amount of time. The advantage with these funds is that interest rate risk and credit rating risk  are minimised due to the short duration (4-91 days for liquid funds and max. 3-4 months for ultra short-term funds)

Personally, I think there is no need to be scared of corporate bond holdings. However, if you don’t like them, easy enough to find debt funds which do not invest in such bonds.

Also, as Mr Raghu Ramamurthy mentioned earlier, short-term gilt funds are a good option too. This eliminates credit risk ( risk of default) but has interest rate risk. So one can use it for slightly longer durations.

5. Why bother with debt funds?

Speaking of duration, if my financial goal is less than 3 years away, there is no need to use debt funds. I get no tax advantage. I can use RDs and FDs with peace of mind.

This is true for long-term goals also when they are only 3 years away from the target date. Just as it makes sense to decrease equity allocation as the target date draws near, it makes sense to get out of all debt funds (except perhaps liquid funds) too. Either we can shift them to safe FDs or switch them to liquid funds.

6. Read why I insist that Debt funds are not an alternative to fixed deposits Distributors sell them as alternatives because it is their job to sell. We cannot be naive enough to take that at face value. Getting financial advice from product sellers is silly.

7. Panic does not help! If a mutual fund is hit by a credit rating downgrade (like the JP Morgan funds), the NAV will fall sharply. If we panic and try to redeem as soon as the AMC lets us to(!), the notional loss could well become a permanent one. Holding on to the fund until the loss is erased (close to when the bond matures) is the best solution given the circumstances.

8. It is not your money!

It is your money before you invest. After you invest, what you get upon redemption is NAV times units held. This is not as the same as “getting your money back”. Once we get into a mutual fund, the collective interest of the unit holder takes precedence.

What are your takeaways from this incident?

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About the Author M Pattabiraman author of freefincal.comM. Pattabiraman(PhD) is the author and owner of freefincal.com.  He is an associate professor at the Indian Institute of Technology, Madras since Aug 2006. Pattu” as he is popularly known, has co-authored two print-books, You can be rich too with goal based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management.  He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice. Pattu publishes unbiased, promotion-free research, analysis and holistic money management advice. Freefincal serves more than one million readers a year (2.5 million page views) with numbers based analysis on topical issues and has more than a 100 free calculators on different aspects of insurance and investment analysis. He conducts free money management sessions for corporates  and associations(see details below). Previous engagements include World Bank, RBI, BHEL, Asian Paints, TamilNadu Investors Association etc. Contact information: freefincal {at} Gmail {dot} com (sponsored posts or paid collaborations will not be entertained)
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