Home / News / India /  With IBC on hold, recovery prospects for mutual funds’ sidepocketed assets bleak

MUMBAI: Mutual funds which have sidepocketed troubled assets to the tune of Rs4,000 crore may find recovery from these accounts difficult in the post lockdown period, with majority of cases under bankruptcy resolution being pushed to later part of the year and the government announcing a halt on fresh insolvency cases for at least six months.

Sidepockets or a segregated portfolio ensures money invested in a mutual fund debt scheme that is linked to stressed assets gets locked until the fund recovers the cash from the company.

Investors can redeem the rest of their money. Sebi had introduced this facility in December 2018 as a means to insulate the healthier assets from the stressed ones. Since then, asset managers have chosen to create over 30 sidepockets for their bond exposures to Yes Bank Ltd, Vodafone-Idea Ltd, Adilink Infra and Multitrading Pvt Ltd, Altico Capital India Ltd, Dewan Housing Finance Ltd (DHFL).

As of April end, debt mutual funds have parked nearly Rs4,000 crore in the so-called side pockets.

As per data provided by rating agency, CRISIL Ltd, these are spread across asset management companies (AMCs) namely – Aditya Birla Sun Life Mutual Fund, Nippon India Mutual Fund, Tata Mutual Fund, UTI Mutual fund and Franklin Templeton India. Nearly Rs3,000 crore of assets are in sidepockets created by Franklin in the six debt schemes that are under the process of winding up.

“The closure of economic activity due to 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 propensity to not litigate due to market perception risks affect their recoveries. Additionally, mutual funds by virtue of their smaller holdings in any NPA case (in their capacity as NCD/bond holders) are not able to drive resolution but are reactionary parties to a resolution that is primarily driven by banks and financial institutions.

"Mutual funds 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 Bankruptcy Code (IBC). Initially the commencement of IBC proceeding was perceived as a threat to enabling resolution but that effect is slowly getting negated," said Ajay Shaw, Partner, DSK Legal.

He added that defaults by bond issuers prior to covid-19 and (if any) during the moratorium relaxations will further compound problems for AMCs.

While AMCs have created some side pockets, it has been a slow process. Nearly Rs5,000 crore of exposure to non-convertible debentures (NCDs) sits out of side pockets and has been written off the books or losses passed on to the investors.

For instance, in case of defaults by Reliance group company Reliance Home Finance Ltd, SBI Mutual Fund passed on the losses to investors while UTI Mutual Fund wrote down Rs2,700 crore due to defaults and downgrades. According to data from Pulse Labs, only about Rs175 crore sits in side pockets created by UTI.

The reluctance to create sidepockets stems from issues of market perception, investors getting jittery over the quality of portfolio and Sebi norms which require the fund manager of the scheme (in which there is a side pocket) to forgo his bonus.

The other major reason for fewer sidepockets and collateral enforcement is the belief that recovery would be better in case of forbearance.

“For banks, the focus has always been lending and recovery but for mutual funds, it has always been about keeping funds liquid to meet redemptions and maximising returns for investors. Thus, mutual funds, in comparison to banks, prefer liquid securities enforceable without legal hurdles," said Shaw.

According to a chief executive officer of a leading fund house, the defaults have primarily occurred in credit risk funds

“But these are still not total write-offs and some recovery could happen. In IL&FS and DHFL, there has been no solution. But if in some other assets there is some solution then there would be recovery and returns would go up," he said.

Jayshree P Upadhyay
Jayshree heads a team of reporters focussing on legal, regulatory, investigative stories. She has worked for over a decade, reporting on financial scams, legal stories and the intersection of corporate and regulatory issues. She is based in Mumbai and has previously worked with Business Standard, Mint, The Morning Context and Bloomberg TV India.
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