Nippon India Mutual Fund – one of India’s largest mutual fund houses.

Franklin Templeton Mutual Fund – one of the most renowned global asset managers.

UTI Mutual Fund -India’s oldest mutual fund house.

I feel such milestones do not carry much meaning if fund houses can’t live up to the brand value and the expectations of investors.

The aforesaid mutual fund houses, by holding toxic debt papers and not taking timely risk management measures, have exposed their debt mutual fund investors to very high risk and performed worse than their smaller counterparts.

For instance, as you may know, investments in schemes of Franklin Templeton Mutual Fund eroded investors’ wealth owing to exposure to high credit risk or rather toxic debt papers of Vodafone-Idea, Reliance ADAG, Amtek Auto, and Jindal Steel and Power in the past.

And now it is Yes Bank.

Yes Bank has repeatedly failed to raise capital in the past. Despite that, Indian mutual funds have an exposure worth Rs 2,731 crore to the Bank.

Table 1: Fund houses investing in Yes Bank debt

Data as per the portfolio as on February 29, 2020
(Source: ACE MF, PersonalFN Research)

On January 6, 2020, my colleague, Divya, warned investors against the probable downside of investing in debt funds having exposure to Yes Bank debt. She wrote:

If you (investors) already have exposure to debt mutual fund schemes with exposure to debt instruments of Yes Bank, you could possibly do away with the ones that would prove perilous to your wealth.

We have been continually tracking the rise and fall of Yes Bank and how it impacts mutual fund investors.

Read: Is Your Mutual Fund Scheme Investing In Yes Bank? Watch Out!

Read: How Yes Bank’s Fall Impacts Your Mutual Funds

After the Reserve Bank of India (RBI) dissolved the sitting board of Yes Bank last week — as a result of which credit rating agencies downgraded Yes Bank debt to “default” grade—-the Net Asset Value (NAV) of many debt mutual funds took a severe beating.

Last week, Nippon Mutual FundUTI Mutual Fund and PGIM Mutual Fund did side-pocketing. Franklin Templeton Mutual Fund also joined the bandwagon.

In layman terms, side pocketing is an accounting method of calculating two NAVs of a scheme by demarcating good assets from troubled assets. Redemptions and purchases are allowed only through the bucket of good assets.

As and when the issues of troubled assets are resolved, investors can liquidate their holdings in that bucket as well.

But what about the measures to recover investors’ hard-earned money locked in toxic assets?

Why couldn’t they resist, and at some point say ‘No’ to Yes Bank’s toxic debt paper?

Table 2: Scheme-wise exposure to Yes Bank’s toxic debt paper

Data as per the portfolio as on February 29, 2020
(Source: ACE MF, PersonalFN Research)

By just following the methodical accounting approach of creating side pockets, does not directly benefit investors.

Mutual funds houses might claim they have created side pockets in the interest of investors; but can we deny a fact that (at times) mutual fund houses overstepped their mandates and took undue credit risks to maximize the returns or improve their performance records?

As you might be aware, RBI, as a part of a restructuring plan for Yes Bank, has decided to write down Additional Tier-1 (AT-1) bonds issued by Yes Bank. AT-1 bonds worth Rs 8,415 crore out of Rs 8,695 crore issued have been written down to zero. In the regulatory filing to the exchange, below is the explanation given:

The perpetual subordinated Basel-III compliant additional tier-1 bonds issued by the bank for Rs 3,000 crore on December 23, 2016, and perpetual subordinated Basel-III compliant additional tier-1 bonds worth Rs 5,415 crore on October 18, 2017, have been fully written down and stand extinguished with immediate effect.

Accordingly, the AT-1 instruments will be fully converted or written-down permanently before amalgamation or reconstitution.

The move is said to be in consonance with the draft reconstruction scheme issued by the RBI.

Earlier, bondholders were hopeful that RBI might allow the conversion of bonds into equity shares, instead of complete write-offs. Some bondholders, including mutual funds, have moved the Bombay High Court against RBI’s decision to write off of AT-1 bonds.

Can mutual funds afford such heavy haircuts?

AT-1 bonds are perpetual in nature and have an equity-like risk profile. Indian mutual fund houses severely undermined the risk involved in the AT-1 bonds and other debt instruments issued by Yes Bank.

In my view, when other bondholders are ready to forgo their dues, mutual funds are likely to find it hard to negotiate with the Bank and RBI.

Remember, creating side-pockets only discourages panic selling from the affected schemes, which, in turn, shields investors to an extent.

Fund managers could have avoided this embarrassing situation by taking timely cognizance of the adverse developments, wherein the risk management control measures should have been triggered.

Now there is a rescue plan being devised for Yes Bank. Seven key lenders will pump in money via the equity route at Rs 10 per share. Here’s what the plan is…

Table 3: Participants who will inject capital in Yes Bank

Lenders At Price (Rs) Subscription Amount (Rs in crore)
State Bank of India 10 6,050
ICICI Bank Ltd. 10 1,000
HDFC Ltd. 10 1,000
Axis Bank Ltd. 10 600
Kotak Mahindra Bank Ltd. 10 500
Bandhan Bank Ltd. 10 300
IDFC First Bank Ltd. 10 250

(Source: Disclosure to the stock exchange)

The aforesaid investments to rescue Yes Bank are approved by the Board of the respective lenders. SBI will hold up to 49% stake in Yes Bank.

Post-capital infusion and write down of AT-1 Bonds aggregating to Rs 8,415 crore, the ‘shareholders’ funds’ will stand at Rs 25,529 crore.

The authorised capital of Yes Bank shall be altered to Rs 6,200 crore (from Rs 1,100 crore) and the number of equity shares to 3,000 crore of Rs 2/- each, aggregating to Rs 6,000 crore. Further, the authorised preference share capital will continue to be Rs 200 crore, going by the Gazetted Notification issued by the Ministry of Finance (Department of Financial Services) for the reconstruction of Yes Bank.

Apart from these seven lenders, it is said that other private investors are also likely to contribute to the rescue plan. Foreign investors may also be roped in at a later stage.

In my view, fund managers will need to keep track of the developments and carefully evaluate them. Moratorium on Yes Bank will be lifted on March 18, 2020, and the new board led by the current administrator, Mr Prashant Kumar as the CEO and Managing Director will take over.

Corporate governance at Yes Bank has to perk up substantially to ensure that the money is managed with ethics, integrity, utmost transparency, and with a strategic long-term plan in place in the interest of investors at large. Injecting capital alone will not solve all the problems.

For these reasons when you choose mutual funds, apart from the returns, assessing the portfolio characteristics becomes very, very important to prevent a rude shock later. Invest in mutual fund schemes from fund houses that follow robust and responsive investment processes & systems.

This article first appeared on PersonalFN here

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