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Fund houses recover side-pocket dues: How much will investors receive?

The gains will only be distributed to those whose units had got segregated earlier

July 29, 2020 / 10:01 AM IST

Allirajan M

Segregated portfolios or side pockets in popular parlance, which were created to separate investments that had gone sour, have started yielding the dues of investors. On July 15, UTI Mutual Fund (MF) received the entire amount (Rs 44 crore) from its investments in the securities of Zee Learn.

The investments in Zee were set aside in segregated portfolios of UTI Credit Risk and UTI Medium Term funds after a downgrade in the ratings of the underlying securities on July 7. Earlier in the month, Franklin Templeton MF received payment from Vodafone Idea (about Rs 1356 crore), whose securities were also downgraded. Following this, Franklin Templeton has disbursed dues to investors for the Vodafone Idea securities held in the side pockets of six of its debt schemes.

Side pockets and your dues

So, how do investors get the amount that flows into segregated portfolios? Investors have to bear in mind that taxes and charges for recoveries made in side pockets are different from their regular investments. First, there is no need to specially apply to get this fund back. The fund house would directly credit the amount to the registered bank account of investors holding these side-pocketed units.

Upon recovery of dues from the issuer in the segregated portfolio, whether partial or full, the fund house will distribute them to investors proportionate to their holdings in the segregated portfolio.

Side-pocketing is a mechanism that keeps the affected part of the portfolio segregated so that the rest of the scheme can be bought and sold by investors. But, as and when the fund recovers the dues from its segregated portfolio, the gains will only be distributed to those whose units had got segregated earlier. New investors do not get a share.

Calculating the amount due to you

If the segregated portfolio has received, say, Rs 1000 crore, the fund house would divide the sum by the total number of units in the scheme. But the entire amount will not come to you. The fund would have different plans such as ‘Growth’ and ‘Dividend’ within the scheme. For instance, if the ‘Retail Plan-Growth’ option had 10 per cent of the AUM (assets under management) of the scheme, it would receive 10 per cent, i.e., Rs 100 crore. If the ‘Growth’ option has 10 crore units, then you would receive Rs 10 per unit.

Remember, the fund house distributes sums as and when it receives payments. So, if only a part of the payment is received, then it would extinguish the units and deduct the same from the investor’s portfolio to that extent.  In the above-cited case, if the scheme had received Rs 200 crore in the segregated portfolio at an earlier date, then it would be adjusted.

The ‘Retail Plan-Growth’ option would have received Rs 20 crore (10 per cent of Rs 200 crore) and paid Rs 2 per unit to investors. The fund house would have extinguished 2 crore units, after distributing the amount to unitholders in the process. For the second payment of Rs 1000 crore, the investor in this case would get Rs 12.5 per unit since only 8 crore units would be available after extinguishing of units.

What is the tax impact?

Amounts received through segregated portfolios are taxed the same way as your regular units are, depending on whether they are from equity or debt funds.

If debt investments, including your segregated units, are sold after three years, then the returns are treated as LTCG (long-term capital gains) and taxed at 20 per cent, with indexation benefit. Indexation brings down the tax outgo as it inflates the purchase cost. Earlier, units in the side pocket were considered created on the day the portfolio was segregated and not on the day the original investment was made for taxation purposes.

This meant that investors had to pay a higher STCG (short-term capital gains) tax for the profits made during a recovery because, typically, fund houses would recover their dues within three years of segregating the portfolio. But the Union Budget 2020 changed this by treating them as LTCG for taxation. Now, even if your portfolio was segregated, say, last year and your fund house recovers and distributes the dues this year, your overall debt fund holding period is taken into account.

If debt funds are sold before three years, they are treated as STCG. The gains are added to the income and taxed according to the slab of the investor.

Can your fund charge management fee?

No investment and advisory fee can be charged by the asset management company (AMC) on the side-pocketed portfolio. But aside from the management fee, your fund house can charge an expense ratio to your segregated portfolio for other expenses such as trustee, registrar & transfer and audit fees. Even so, your fund house can only charge this upon recovery of the amount in your segregated portfolio.

first published: Jul 29, 2020 10:01 am