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Dangerous Investment

by | May 19, 2019 | Finance, Scams

What is a Dangerous Investment?

In my opinion, a dangerous investment is one which you have not done the complete research and something totally unexpected happens. Sometimes even if you have done thorough research but it was beyond your imagination.

First, a disclaimer – I do not like any fixed income product and am biased against them. I feel they are bought with wrong assumptions.

I am referring to a product called the FMP (Fixed Maturity Plan). Most MF distributors sell this product saying it is as good as an FD, but with the possibility of a higher return and with lower tax.

The ‘lower tax’ part comes from the holding period – the product is designed in such a way that it gives long term capital gains benefit. Let’s ignore that for the present.

It is for a fixed period – let’s say 18 months. By law, the fund house cannot say what returns they will give (unlike the FDs), since it is not guaranteed.

In this case, the Fund Manager (FM), as he knows the duration of the Plan, will go out and find bonds that are ‘AAA’ rated – very safe and which mature around the time the Plan ends – 18 months in this case. All fine till now.

However, ‘AAA’ bonds are almost safe as FDs. Therefore, the interest rates will also be close to FDs. Then why would anyone invest in this FMP unless it gives a higher rate? Now, how to get a higher rate?

Please read this carefully. This is what is not explained to the investors. The FM will decide to invest around 70% (this is a random figure) of the total amount in the very safe AAA bonds and then takes a chance with the remaining 30% of the amount in say, AA bonds, which are not as safe as the AAA bonds and hence, have to give a higher rate of interest to compensate for the higher risk. What is not explained to the customers that an element of risk has been introduced – who takes the risk? Obviously, the client who invests in the FMP. Because of this risk, the FMP is not ‘like’ an FD.

In a recent case, HDFC Mutual Fund, Kotak MF and some others had exposure to bonds of Essel group, which defaulted on the repayment of the money when the plan ended. The end result was that the fund houses could not repay the FMP investors their money. Eventually, they came out with a solution and have paid out part of the money and extended the date up to September 2019 to repay the remaining. It might be that no one will lose money, but just that the investors will not get the money when they need it.

The fund houses had taken precautions – they had got shares of Zee Entertainment (the parent company) pledged with them against the payment made for the bonds. But that did not turn out to be good. Sometimes, I wonder why these highly educated and competent people do not realise simple things. What happens to the stock price when the company cannot repay its borrowings? Everybody realizes something is wrong and starts selling the stock. In addition, the MF companies also started selling the stock which had been pledged with them. The result – the stock price fell by 30% in a day! Then better sense prevailed and the MF companies stopped selling. So, they are holding stocks now, but don’t want to sell because it will be self defeating.

I wonder why these smart chaps did not monitor the accounts of the company when they have lent so much money to them? That would have given a warning much earlier and they could have taken action to protect their investment.

Lastly, how does it make sense to take collateral that would get affected by the very action of not honouring the bonds? Why not take the company land or the director’s homes as collateral?

Niranjan Bangera


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Written By: niranjan

Financially Stupid Niranjan


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