After 14 June, Tata Corporate Bond Fund, Tata Medium Term Fund, and Tata Treasury Advantage Fund will have two different portfolios
Stung by sharp write-downs in three DHFL-exposed schemes, Tata Asset Management (Tata MF) became the first fund-house to opt for the side-pocketing mechanism, which was instituted by SEBI last year. On June 6, Tata MF took the investor-friendly step of creating segregated portfolio of debt and money market instruments. In this case, the credit event was a downgrade of DHFL to ‘default’ (D) grade after the housing finance firm reportedly defaulted on over Rs 900 crore of interest payments just days ago. DHFL has maintained that it did not default but has only delayed the payment.
However, under rules, even a day of delay is a default. This compelled debt MF schemes to write down 75% of their investment value in DHFL debt securities, leading to massive losses in fixed-income schemes.
This is a win-win situation for both investors as well as AMCs. In a credit event, usually, redemption pressure increases as investors rush to safety by exiting from a scheme which has exposure to securities that have turned illiquid. For meeting these redemption requirements, a fund manager has to sell other good quality securities. It isn’t fair for those investors who stay invested as the percentage of bad quality assets increases in the scheme. By creating a side pocket, the distribution of the risk will be equal among all investors as well as the fund manager will not be pressured to meet the liquidity requirements and business can run as usual.
It is estimated that over 100 schemes have exposure to DHFL debt. Among mutual fund houses, exposure to DHFL group is highest in UTI Mutual Fund (over Rs 1,900 crore), followed by Reliance Nippon (over Rs 1,100 crore), Franklin Templeton (over Rs 500 crore), Axis MF (over Rs 400 crore), L&T (over Rs 300 crore), DHFL Pramerica and DSP Mutual Fund (over Rs 200 crore each).
Coming to Tata Mutual Fund, as on April 30, 2019, the fund house’s Tata Corporate Bond Fund, Tata Medium Term Fund, Tata Treasury Advantage Fund, Tata FMP – Series 55 – Scheme E, Tata Retirement Savings Fund – Moderate, Tata Retirement Savings Fund – Moderate and Tata FMP – Series 55 – Scheme F had exposure to DHFL.
Now, Tata MF has opted for side-pocket for three schemes – Tata Corporate Bond Fund, Tata Medium Term Fund, and Tata Treasury Advantage Fund.
Why these three schemes? It may be because they are most exposed to DHFL. For instance, Tata Corporate Bond had 28% of its money in DHFL. Tata Medium Term Fund had nearly 15% of its money in DHFL.
Tata Asset Management Limited (AMC) has already sent individual written communication as well as released a notice advertisement in newspapers for enabling the provision of segregated portfolio in the captioned schemes. This is the first fund-house to opt for the side-pocketing mechanism
Investors have been provided 30 days’ load free exit period to redeem from the schemes. The 30 days’ load free exit period will expire on 14th June 2019, Tata MF said.
Rating agencies have downgraded long term rating of Dewan Housing Finance Limited (DHFL) to default ‘D’ on 5th June 2019.
The AMC proposes to create segregated portfolio of securities of DHFL held by the above three schemes immediately after expiry of mandatory load free exit period of 30 days’ subject to approval by Trustee of Tata Mutual Fund.
Ongoing subscription in the captioned schemes has already been suspended. This means new investors cannot buy.
What is side pocketing? SEBI has allowed the creation of a side pocket in case of a credit event provided the credit ratings of securities in a portfolio fall below investment grade, separating illiquid securities from the rest of the portfolio and running this illiquid portion as a subset of a fund till the resolution happens and money is recovered.
So, side pocketing is a process of segregating bad quality assets, thereby creating two different pockets and calculating separate NAV for each pocket. These two NAVs would be subsets of the original scheme wherein the NAV of good quality assets will behave like normal, actively managed fund. Investors can redeem this portion of their investments present in good quality assets, however the portion in the illiquid or bad quality assets will be locked in till the resolution of these assets (settlement with issuer in full amount or in parts).
Impact on the Investors
1. Investors redeeming their units will get redemption proceeds based on the NAV of main portfolio and will continue to hold the units of segregated portfolio.
2. All investors in the scheme as on the day of creation of segregated portfolio shall be allotted equal number of units in the segregated portfolio as held in the main portfolio.
3. Upon future recovery of money from the segregated portfolio, whether partial or full, it will be distributed to the investors in proportion to their holding in the segregated portfolio.
4. AMC will enable listing of units of segregated portfolio on the recognized stock exchange within 10 working days of creation of segregated portfolio and also enable transfer of such units on receipt of transfer requests.
5. AMC will disclose separate NAVs of segregated and main portfolios from the date of creation of segregated portfolio.
6. Once the segregated portfolio is created, no subscription and redemption will be allowed in the segregated portfolio of the captioned schemes.
RupeeIQ take: We commend the move of Tata AMC to create a side pocket for the DHFL papers that have gone sour. This at least gives hope to investors that they have an opportunity to capture the value that has been lost as of now. Besides, they have an option to redeem the units in the good portfolio as and when they would like to without affecting the units in the side pocket.
Additional Read: Are AMCs shying away from side pocketing because of negative impact on fund manager compensation?
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