Side Pocketing in MFs

 

Side-pocketing allows mutual funds to segregate the portfolio into two, separating the bad assets (illiquid assets) from the good ones (liquid assets). Advantage  of investors as it prevents panic redemption and ring-fences liquid assets. Advantage MFs because it prevents the fund house from selling liquid papers to meet redemption requests. Also, investors who take the hit in side-pocketing get the full upside of future recovery when the credit event happens.

Side pocketing is a technique to safeguard investors in instruments that have exposure to risky assets.

It is basically an accounting method that is used to separate illiquid investments from liquid and quality investment, in a debt portfolio.

Back in 2016, post the JP Morgan Asset Management (India)’s investments in Amtek Auto defaulted and the fund house resorted to the side pocket, the Association of Mutual Funds of India (AMFI) approached SEBI for the creation of rules surrounding side-pockets when the market faces a credit event.

However, SEBI did not accept the recommendation then.

In 2018, many debt schemes saw a sharp fall in the NAV. After these schemes, investments in Infrastructure Leasing & Financial Services Ltd (IL&FS) and some of its subsidiaries saw credit rating downgrades.

This crisis resulted in the changeof regulation in debt funds.

Prolonged problems in financial world need financial innovations before they turn into a systemic risk or a market level contagion. This might have been the thought process in the policy-making process of Securities and Exchange Board of India (SEBI) when it brought out the side-pocketing option in December 2018 in mutual funds for distressed assets.

UTI Mutual Fund has made enabling provision for side pocketing in three of its schemes – Arbitrage Fund, Multi Asset Fund and Equity Savings Fund – by filing additional scheme information document with SEBI.

 

The provision will come into force from September 25 , 2020 and investors who do not agree with the provisions have the option to exit the schemes without incurring any exit load till then.

Is there a base for such side pocketing?

In February 2003, following the repeal of the Unit Trust of India Act 1963, UTI was bifurcated into two separate entities. One is the Specified Undertaking of the Unit Trustof India with assets under management of Rs 29,835 crore as at the end ofJanuary 2003, representing broadly, the assets of US-64 scheme, assured return and certain other schemes.

The second is the UTI Mutual Fund Ltd, sponsored by SBI, PNB, BoB and LIC. It is registered with Sebi and functions under the Mutual Fund Regulations.

SUUTI, which if sold at 26 July 2016  prices can be expected to fetch aminimum of ₹61,000 crore, far more than the whole year’s disinvestment target of 2015-16 amounting to ₹56,500 crore! It has now invited India’s leading merchant bankers to make a pitch for aiding it in the process of liquidating SUUTI and raising cash from it.

The lesson learned is that one has to have faith in the strength of the economy to bounce back

Happy Investing