Troubles in the debt market have finally reached the doorsteps of mutual fund investors, with Kotak Mahindra Asset Management Co. Ltd withholding part of the redemptions from one of its fixed maturity plans (FMP).
The development has attracted the attention of the stock market regulator, which has asked all mutual funds to provide details of debt schemes backed by promoter shares.
Two Essel Group companies in which the FMP had invested had not repaid in full. That forced the asset manager to hold back part of the payments when the plan matured on 8 April.
The redemption clock began ticking in January when the Essel Group companies, to which mutual funds had lent a combined ₹7,000 crore against debt securities, neared a payment default. The funds agreed not to sell the pledged promoter shares until end-September. In the meantime, Kotak’s FMP—which too had lent to Essel—has come up for redemption, rendering the AMC unable to pay the entire redemption amount.
Lakshmi Iyer, head of fixed income at Kotak AMC, said except for one FMP, the fund had returned “100% of the principal amount" to investors. “The impact is primarily on the returns. We have kept aside some units with their corresponding net asset value (NAV) and we expect to allow investors to realize these units once the Essel Group companies pay us back, latest by 30 September 2019. We refrained from selling the shares that were collateral for the papers concerned because this would have caused a market panic and wouldn’t have allowed us to realize their full value," Iyer said over the phone.
FMPs are close-ended funds with a fixed maturity period. They invest in debt instruments, with maturity matching the tenure of the scheme. In this case, the loan was given against pledged shares of Zee Entertainment Enterprises Ltd, the flagship company of Subhash Chandra’s Essel Group.
Nilesh Shah, managing director of Kotak Mahindra AMC, said that in return for forbearance on selling the collateral against the Essel Group companies’ debt, the AMC has secured additional concessions. “We have taken personal guarantee of Subhash Chandra, the promoter of Essel Group, over and above Zee Entertainment shares for better security. We have also secured upside sharing on a graded basis on stake sale in Zee over and above the coupon rate of the existing debentures," he said. The Essel Group has put 50% stake in Zee on the block to raise money and repay debt.
An Essel group statement said: “The lenders have unanimously extended support to the Group and the same has positively resulted in saving the loss of public money. The arrangement with the lenders has also given the Group, the required time to realise the right value from the stake sale of ZEE Entertainment Enterprises Ltd. and has indeed stabilized the stock performance of the mentioned public listed entity."
Separately, HDFC Asset Management Co. Ltd, India’s largest asset manager, on Wednesday extended the maturity of one of its FMPs maturing on 15 April 2019 to 29 April 2020.
“The purpose of rollover or extension is due to current interest rate scenario and portfolio positioning; the yields prevailing in the short-maturity bucket present an option for investors to lock in their investments at current prevailing yields," an HDFC AMC statement to investors said.
Typically, in a situation where assets are not realized, AMCs have three options—take a hit on their books, roll over the scheme or mark down the value of security to zero.
Altogether, nine AMCs have lent to Essel Group across 87 schemes, including FMPs and open-ended debt funds. As a percentage of scheme assets, exposure to Essel Group ranges from a negligible amount to as much as 21.01% in Kotak FMP Series 187. Kotak AMC has exposure to Essel Group debt across six FMPs.
Other funds that have exposure to Essel Group debt are SBI Asset Management Co. Ltd, HDFC AMC, Reliance Nippon Life Asset Management Ltd, Franklin Templeton Asset Management (India) Pvt. Ltd, Aditya Birla Sun Life AMC Ltd, UTI AMC Ltd, Baroda Asset Management India Ltd and ICICI Prudential AMC.
The Securities and Exchange Board of India (Sebi) was watching the situation closely, said a person aware of the matter.
“Sebi will write to Kotak for an explanation on whether trustee approvals were taken. Sebi has so far not given any opinion on the agreement between the fund houses to not sell the Essel Group securities. But Sebi is concerned and has asked all fund houses to give details of debt schemes, which hold paper backed by promoter shares. The roles of trustees on giving approval to such debt schemes is being monitored very closely," said this person.
Kotak AMC’s action and the regulator’s response are likely to lay down a precedent for other mutual funds exposed to bad debt. In December 2018, Sebi had allowed so-called side pockets for mutual funds, to segregate bad debt without affecting the larger scheme.
“This is not a side pocket in the literal sense but more of holding back the securities that were not realized," said Kaustubh Belapurkar, manager- research at Morningstar.
Fair valuation norms require all schemes holding other bonds of the defaulting issuer taking a write-down on their holdings; this would impact NAV and returns of those funds, said Arvind Chari, head-fixed income and alternatives at Quantum Advisors Pvt. Ltd.