Now that a majority of Franklin Templeton mutual fund's unitholders – of the six debt schemes – have voted in favour of winding-up, another set of investors are still anxious. Unitholders stuck with the side-pocketed units of these schemes have been wondering if they too would get their money back soon. The Supreme Court (SC) will give the final clearance on the second vote (the vote that would seek authorization of either the trustees or an external authority to be in charge of selling securities and winding up) on January 25, 2021. However, in all likelihood, the verdict will not have any bearing on the segregated units. Here’s why:
To be sure, if FT MF finds buyers for such units in the open market at reasonable valuations, it can separately monetise these assets and repay unitholders.
Portfolios segregated before winding up
As per the guidelines laid down by the Securities and Exchange Board of India (SEBI), fund houses can isolate risky assets from their other holdings and cap redemptions. Once separated, the segregated units will represent the value of the troubled assets. The unaffected portion of the portfolio will have all the other securities; units of this portfolio can continue to be bought and sold.
Several of these six wound-up Franklin Templeton debt schemes had segregated units as they held securities of firms such as Vodafone and Yes Bank, which had defaulted and were then downgraded. But these units were segregated even before the fund house decided to wind up these schemes.
Side-pockets or segregated portfolios are carved out of the main portfolios of schemes to hold investments that have been downgraded to below-investment grade (anything below BBB minus).
“Side-pocketed units are separated units linked to certain specific investment of the scheme. The fund house and its debt team need to oversee such side-pockets to facilitate efficient recovery from such investments,” says Amol Joshi, founder of Plan Rupee Investment Services.
Paritosh Gupta of Gupta Law Associates, one of the lawyers who represented the Ahmedabad-based petitioners in the Franklin Templeton case says, “such matters are always restricted to the main portfolio and segregated portfolios are kept out."
In simple words, the recovery of segregated assets continue, irrespective of whether the fund house had taken a decision to wind up the schemes. The issues are separate.
The future of segregated portfolios
Recovery of money from bonds linked to segregated assets depends on how soon the fund house can recover amounts from those companies. And since the value of such assets is already marked down, there may be limited or no market for dealing with such bonds. That is why the orderly winding down of schemes, as ratified by the recent Franklin Templeton investor vote, doesn’t impact the segregated portfolios.
In other words, such units will be held in separate portfolios by the fund house till the debt is fully repaid by the company. As and when interest payments are received, unitholders get the funds deposited in their accounts.
One side pocket of a FT MF scheme held debt papers of Vodafone Idea, which was fully repaid in July last year. Franklin India Low Duration Fund, Franklin India Short Term Income Plan, Franklin India Income Opportunities Fund, Franklin India Credit Risk Fund, and Franklin India Dynamic Accrual Fund hold side-pocket units of another Vodafone Idea security. This second set of Vodafone investments matures on September 2, 2023. But mutual fund industry observers say that the fund house is most likely to exercise a ‘put’ option that is due to come up on September 3, 2021.
A ‘put’ option gives the right to the bondholders to enforce repayment of the principal amount before maturity. Call option allows the borrower to call back the bond before its maturity by paying back the principal amount.
Franklin India Short Term Income Plan, Franklin India Credit Risk Fund, Franklin India Dynamic Accrual Fund hold side-pocket units of YES Bank. The rating on this instrument was altogether withdrawn by credit rating agencies.
Recovery in the case of side-pocketed units linked to YES Bank may be much more difficult, as the Reserve Bank of India has decided to write-down the additional tier-1 bonds (AT-1) of YES Bank. Along with FT MF, other fund houses holding these bonds have moved the courts seeking relief.