MFs seek more disclosures from rating agencies to improve predictability

Raters need to share weights being assigned to risk-factors and rating action in different scenarios, say mutual funds

The Securities and Exchange Board of India’s (Sebi) guidelines for rating agencies on disclosures has left some room to be desired. 

According to mutual fund (MF) players, this will help the fund manager take a more informed investment call if it knows the scenarios in which the ratings could change. Further, a detailed disclosure on the weightage being accorded to each rating factor within different sectors will help improve predictability of rating changes, the MF players said.  

On Tuesday, Sebi issued guidelines that require rating agencies to make disclosures on promoter support, linkages with subsidiaries, and liquidity position of entities being rated, to meet near-term payment obligations. 

Sebi’s move has been seen as a direct fallout of the IL&FS episode, as lack of clarity on similar issues were seen to be the cause of the entity’s sudden multi-notch downgrade to default status. The sharp rating action had hurt the net asset value (NAV) of quite a few schemes that were holding IL&FS group papers. The fund houses had to take a 50 per cent haircut on their exposures. In some cases, the haircut was 100 per cent. 

“The rater uses historical data to come up with ratings. However, investors need to base their decisions on the future outlook. So, it is important that rating agencies start sharing key assumptions based on which they came up with the ratings. And, if these assumptions change, how will the ratings get impacted. The fund managers can also test if these assumptions are valid,” said Pankaj Pathak, fund manager (fixed income), Quantum MF.   

 

Experts say if disclosures were up to global standards, fund managers would have been able to steer clear of certain sectors under pressure currently. 

“Most NBFCs were growing at 30-40 per cent. This meant their internal equity generation was quite high. So, the leverage was contained to that extent. Fund managers would have had a better reference to take their investment decisions if rating agencies had disclosed how the ratings could change, as and when this high-rate of growth starts to plateau,” said another fixed-income fund manager, requesting anonymity.

Disclosures on weights being assigned to sector-specific risk factors and how ratings can change in different scenarios are already being made in more developed economies. 

For instance, while downgrading outlook on Tata Motors from stable to negative on Wednesday, Moody’s disclosed scenarios in which the rating action could turn negative.

“The ratings could be downgraded if there is any pressure on JLR’s ratings, or if Tata Motor’s ex-JLR businesses deliver sub-par performances on account of weak market conditions, input cost pressures, disappointing new products, or a significant ceding of market share. On specific credit metrics, Moody’s will watch for a downward rating if consolidated debt/Ebitda exceeds 4.5 times, and Ebitda margins remain below 4 per cent, both on a sustained basis,” Moody’s said in its note issued on Wednesday.

On the positive side, Moody’s said, “Any revision to Moody’s support assumptions from Tata Sons will also prompt a revision to the one-notch uplift in Tata Motor’s ratings. A stabilisation in JLR’s outlook would be a precursor for TML’s ratings outlook to return to stable.”

The note pointed out the principal methodology being used for the rating was ‘Automobile Manufacturer Industry’, which uses nine rating factors for auto firms.  In the methodology, market position and product strength has been given 30 per cent weightage, Ebitda margin 20 per cent, and leverage 10 per cent weightage.