What does the Altico bonds default mean for MF investors?

Credit quality issues in debt instruments continue to haunt the mutual fund industry. The latest episode concerns bonds issued by Altico Capital. The company defaulted on interest payments of around Rs 20 crore on External Commercial Borrowing (ECB) that were due to the Dubai-based Mashreq Bank. This prompted the rating agencies to downgrade Altico bonds to below investment grade.

Fourteen debt mutual funds, including FMPs from UTI and Reliance AMCs, that held the NCDs issued by Altico took a hit of up to 8 per cent in their NAV in a single day. According to MF research application, ACEMF, these schemes’ investments in NCDs issued by Altico amounted to around ₹538 crore (as of August 2019).

Altico was established in 2004 by funds managed by Clearwater Capital Partners India Pvt Ltd for wholesale lending to capital-constrained Indian small and medium enterprises. It focuses on high-yield mortgage backed loans to developers in the real estate sector.

Segregation of portfolio

On the day of default (September 12, 2019), the rating agency CARE downgraded the NCDs issued by Altico from ‘AA-’ to below investment grade of ‘B’. Since the security has been downgraded to “B” i.e. below investment grade, mutual funds having these distressed assets in their portfolio, have marked down the value of these assets.

On September 13, 2019, the long-term issuer rating of Altico was downgraded to ‘D’ by India Ratings and Research.

UTI mutual fund has a combined exposure of Rs 334 crore in these NCDs in seven schemes. Of these, the UTI credit risk fund holds Rs 201 crore, while the rest has been kept in six UTI FMPs. The NAV of the UTI credit risk fund was marked down by around 5.7 per cent, while the NAVs of the six FMPs were marked down by 6-8 per cent.

Subsequently, UTI AMC announced creation of a segregated portfolio (also called side pocketing) in UTI credit risk fund for the distressed assets on September 13, 2019. The side pocketing option is limited to open-ended schemes and such provision is not available in the six FMPs.

Delay in side pocketing

Eight schemes from Reliance Mutual Fund, including Reliance Ultra Short Duration Fund and seven FMPs, have a combined exposure of Rs 204 crore in distressed Altico NCDs.

In a press release, Reliance AMC reported that it would create the segregated portfolio of securities of ACIL held in Reliance ultra short duration fund immediately after expiry of the mandatory load-free exit period of 30 days (i.e. September 25, 2019).

This is because, recently, SEBI came out with a regulation that mandates that all AMCs should get approval from their trustees for enabling the provision of segregated portfolio in their open-ended schemes. After the approval, the AMCs should provide unitholders the option to exit the scheme in 30 days without exit load.

In this case, Reliance AMC got approval from its trustee for creation of a segregated portfolio and the mandatory load-free exit period of 30 days ends on September 24, 2019. So the side pocketing in Reliance ultra short duration fund will be created on September 25, 2019. Till that time, all ongoing subscriptions in this fund have been suspended.

Reliance ultra short duration fund held more than Rs 150 crore in Altico NCDs and marked the NAV down by 4 per cent. The NAVs of the seven Reliance FMPs were marked down by 1-7.4 per cent.

What for investors?

Money recovered from Altico, whether partial or full, will be distributed to investors in proportion to their holding in the segregated portfolio. No subscription and redemption will be allowed in the segregated portfolio of the captioned schemes. However, these schemes with segregated portfolio, will be listed in the exchanges. The unitholders may exit through the route.

However, liquidity would be an issue in the exchanges.