One of India’s largest mutual funds in the debt space, Franklin Templeton Asset Management has amended its schemes to enable side pocketing. Side Pocketing allows mutual funds to set aside a portion of their units in lieu of bad debt. The move comes closely on the heels of Ind-Ra’s downgrade of Vodafone Idea debt on 1st November to BBB. This rating is one notch above junk and a downgrade below this level triggers write-off among mutual funds as per a matrix set out by the Association of Mutual Funds of India (AMFI). Several schemes of Franklin Templeton are exposed to Vodafone Idea debt as Mint wrote here. Franklin India Credit Risk Fund, Franklin India Income Opportunities Fund, Franklin India Short Term Income Plan and Franklin India Dynamic Accural Fund have exposures of 4.39%, 3.56%, 3.54% and 2.18% respectively according to data from Rupeevest.
Unit holders will be allowed to exit the Franklin schemes in question without paying exit load from November 25th to December 24th, 2019. However they will be liable to pay capital gains tax on any gains in their mutual funds. This tax is imposed at slab rate for holding periods of 3 years or less and at 20% within indexation for longer holding periods. The side pocketing amendment applies across the debt funds of Franklin Templeton AMC including Franklin India Liquid Fund, Franklin India Corporate Debt Fund, Franklin India Short Term Income Plan, Franklin India Income Opportunities Fund and Franklin India Credit Risk Fund. However readers should note that it is only an enabling provision and it is not compulsory for the AMC to carry out side pocketing in case of a downgrade.
Side Pocketing (formally called creation of a segregated portfolio) allows mutual funds separate out a portion of their portfolios in lieu of bad debt. Existing unit holders receive proportionate units in this ‘side pocket’ which they can redeem when there is recovery against debt. Other units can be redeemed at will, enabling the scheme to remain liquid. Fresh investors in the scheme are not allotted units in the side pocket to prevent existing investors from being diluted when there is recovery. The procedure was introduced by the Securities and Exchange Board of India (SEBI) almost a year ago in December 2018.