Home >Mutual Funds >News >Recovery prospects for MFs’ stressed assets turn bleak

Mutual funds, which have side-pocketed troubled assets worth 4,000 crore, may find it difficult to recover them in the post-lockdown period, with the government announcing a halt on fresh insolvency cases for at least six months and a majority of ongoing cases being pushed to the later part of the year.

As of end-April, debt mutual funds have parked nearly 4,000 crore in the so-called side-pockets. These are spread across asset management companies (AMCs), including Aditya Birla Sun Life Mutual Fund, Nippon India Mutual Fund, Tata Mutual Fund, UTI Mutual fund, and Franklin Templeton India, according to rating agency Crisil Ltd. Nearly 3,000 crore of the assets are in side-pockets created by Franklin in the six debt schemes, which are under the process of winding up.

Side-pockets, or a segregated portfolio, ensures money invested in MF debt schemes, linked to stressed assets, gets locked until the fund recovers the cash from the company.

Investors can redeem the remaining amount. The Securities and Exchange Board of India (Sebi) had introduced this facility in December 2018 to insulate healthier assets from stressed ones. Since then, asset managers have chosen to create more than 30 side pockets for their bond exposures to Yes Bank, Vodafone-Idea, Adilink Infra and Multitrading Pvt. Ltd, Altico Capital India, and Dewan Housing Finance Corp. Ltd.

“The closure of economic activity because of the lockdown would have slowed recovery of side-pocketed debt across AMCs," said Gaurav Awasthi, senior partner, IIFL Wealth.

Mutual funds typically are not aggressive on recoveries. Fewer legal remedies as compared to banks and the propensity to not litigate because of market perception risks affect their recoveries. Additionally, mutual funds, by virtue of their smaller holdings in any non-performing asset case in their capacity as non-convertible debentures/bond holders, are not able to drive resolution, but are reactionary parties to a resolution that is primarily driven by banks and financial institutions.

“MFs would prefer not getting into litigation as there are incidental risks, such as market perception, if fund houses begin to litigate. Only as a last resort have fund houses gone to Insolvency and Bankruptcy Code (IBC). Initially, the commencement of IBC proceedings were perceived as a threat to enabling resolution, but that effect is slowly getting negated," said Ajay Shaw, partner, DSK Legal.

Defaults by bond issuers prior to the covid-19 outbreak and, if any, during the moratorium relaxations will further compound problems for AMCs, Shaw said. “The IBC moratorium is likely to impact mutual funds’ ability to address a default situation under IBC during the moratorium."

AMCs have created some side pockets, but it has been a slow process. Nearly 5,000 crore of exposure to NCDs sits outside the side-pockets and has been written off the books, or the losses were passed on to investors.

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