In the past 2-3 years, investors have been growing anxious over increasing instances of rating downgrades and defaults of bonds held by debt mutual funds.

The recent episode of certain fixed maturity plans (FMPs) of Kotak Mutual Fund not paying investors in full on maturity has only made matters worse.

What was the crux of the issue?

These FMPs had invested in bonds issued by Essel Group, which was not able to pay the dues on its bonds. Hence, the FMPswere not able to pay a portion of the realisable value of the debt securities — pertaining to Essel Group — to the investors.

The entire episode

Three FMP series from Kotak Mutual Fund — 192, 127 and 183 — that matured on April 4, 8 and 10, respectively, settled only a part of the redemption proceeds to their unit-holders. Two of the FMPs (series 127 and 183) had invested in debentures of distressed Essel Group companies — Konti Infrapower and Multiventures, and Edisons Utility Works. These debentures had a A+(SO) rating and carried the maturity date of April 8, 2019.

Though these debentures were secured by a pledge of equity shares of Zee Entertainment Enterprises, Kotak AMC decided not to invoke the pledged shares and liquidate the securities. Why?

If the AMC or other lenders chose to sell the pledged shares, it would have resulted in a steep erosion of the underlying value of such shares, fetching a very low amount for the AMC. This, in turn, would have hurt investors as they would have realised only a meagre portion of the value of debt securities pertaining to Essel Group. So, lenders including Kotak AMC entered into an agreement with the promoters of Essel Group, deciding not to sell the pledged shares and provide time till September 30, 2019. Kotak FMP series 183 and 192 also had investments in the defaulted debentures issued by the IL&FS Transportation Networks, wherein the recovery is sill uncertain and will depend on the resolution plan achieved by the new board/NCLT (National Company Law Tribunal).

What next for investors

Ideally, on the maturity of an FMP, an investor gets the principal amount and the returns (accrued interest) on his investment. In this case, since Essel Group has not been able to pay the dues on bonds issued by it, investors will be paid the amount excluding the portion stuck in the three debentures.

While the unit-holders in Kotak FMP series 127 and 192 got their principal amount along with some portion of the returns, the unit-holders in series 183 received marginally less than the original amount invested.

Essentially, the returns (principal plus accrued interest) with respect to Essel Group is retained in the scheme. This will be paid back to the investors when Essel repays the money. If, however, Kotak AMC is not able to recover the dues from Essel Group by September 30, the investors will lose that portion of the money entirely.

The remaining three Kotak FMPs maturing in the mid of April and May will face a similar fate. If one considers their current NAV, they are expected to repay only marginally higher than the initial invested amount.

Other FMPs

HDFC AMC, which has similar issues with its FMPs with exposure to Essel Group, has instead decided to extend the maturity of the fund. It has planned to extend the maturity of HDFC FMP-XXXV-1168D-Feb 2016(1), which was earlier due for maturity on April 15, 2019, by a year. The FMP holds an investment of ₹67 crore, or 20 per cent of the assets in the two debentures issued by Essel Group companies.

According to MF research application ACEMF, 47 FMPs issued by fund houses including Aditya Birla Sun Life, HDFC, ICICI Prudential, Kotak and Reliance have investments in debentures issued by Essel Group companies — amounting to around ₹1,400 crore (as of March 2019). Of these, 23 FMPs are maturing between April and September. These AMCs are expected to either extend their maturity or hold back the assets held in the distressed assets, like how Kotak AMC did.

Watch out

These instances highlight the risk in FMPs. If you are a conservative investor, consider FMPs with relatively high-rated bonds with AAA/A+ rating in their portfolio.

You should take a close look at the intended credit profile of the FMP’s portfolio which is provided in the Scheme Information Document (SID, or offer document), at the time of the launch. Remember, since FMPs are close-ended funds, investors do not have an exit option.

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