Home / Mutual Funds / News /  Sebi fixes cap on MF investment in debt with special features

Mumbai: Mutual fund schemes can invest a maximum of 10% of their assets in debt with special features such as perpetual bonds, the market regulator said, with a maximum of 5% in a single issuer.

The limits will apply only to new investments beginning 1 April.

Banks are common issuers of additional tier-1 (AT-1) and additional tier-2 (AT-2) bonds, also called perpetual bonds since they do not have a fixed maturity date. However, these bonds can be called in, or repaid, at certain intervals.

Funds with investments in such bonds or even enabling provisions to invest in them should facilitate side-pocketing in their schemes, a Securities and Exchange Board of India (Sebi) circular said.

Side-pocketing refers to creating a separate portfolio of soured debt, allowing investors to exit the rest of the scheme without giving up on the chance of recovery in the debt. Sebi said a conversion of such special bonds to equity can be a trigger for side-pocketing.

Perpetual bonds are designed to absorb losses if a bank’s capital dips below specific levels, say, due to high levels of bad loans. This played out during the Yes Bank crisis in early 2020, when the struggling lender wrote down AT-1 bonds and mutual funds holding them faced losses.

“I don’t think this will be a major issue for most mutual fund schemes. I think banking and PSU debt funds will see some impact as they are required to invest 80% of their assets in debt issued by banks and public sector enterprises. However the treatment of perpetuals as debt with 100-year maturity will force schemes with maturity restrictions like short term debt funds to shed such bonds. Moreover all schemes holding them will see much higher effects from interest rate movements," said Arvind Chari, chief investment officer (CIO) at Quantum Advisors India.

The circular also laid down norms for valuation of perpetuals, stating that the maturity of such bonds shall be taken as 100 years. The regulator further barred close ended mutual funds from investing in such bonds.

ABOUT THE AUTHOR

Neil Borate

Neil heads the personal finance team at Mint. A former colleague called them 'money nerds' and that's what they are. They cover topics like mutual funds, taxation and retirement, all to improve your chances of building wealth. Neil graduated with a degree in law and economics. He passed the CFA Level I exam and began his writing career at Value Research, a mutual fund research firm in 2016. He joined the personal finance team Mint in 2019. Everyday, the Mint Money Team tackles personal finance questions such as where to invest and where to borrow, through articles, charts and reader queries. They also have a daily podcast - 'Why Not Mint Money' and an annual ranking of mutual funds - the Mint 20.
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