Mounting Trouble: UTI MF to Side-Pocket Exposure to ZEE Learn Following Rating Downgrade

Jul 11, 2020

More troubled times lie ahead for investors in debt schemes of UTI Mutual Fund. The fund house has decided to segregate (side-pocket) its exposure to Zee Learn Limited (ZLL) in two of its debt schemes -- UTI Credit Risk Fund and UTI Medium Term Fund.

UTI Credit Risk Fund had an exposure of 9.11% of its assets, worth Rs 40.7 crore as on June 30, 2020, to debt papers of ZLL, while UTI Medium Term Fund had an exposure of 3.03% valued at Rs 3.4 crore.

UTI MF took the decision after CARE Ratings downgraded ZLL's non-convertible debentures (NCDs) maturing on July 08 to B (below investment grade) from AA with a Negative outlook.

According to a press release from CARE Ratings, the AA rating was assigned to ZLL based on an unconditional and irrevocable Letter of Undertaking (LoU) by Zee Entertainment Enterprises Limited (ZEEL).

ZLL was supposed to pay the NCD obligations in Debt Service Reserve Account (DSRA) 30 days prior to the due date. In case of any shortfall in servicing debt obligations, ZEEL was supposed to pay the balance amount at least seven days prior to the due date, i.e. July 02.

However, neither ZLL nor ZEEL has funded the DSRA account till date. Given the company's non-adherence to the structure and non-funding of the shortfall in NCD obligations, CARE decided against giving the benefit of Credit Enhancement to the NCDs.

The rating revision had factored in the likelihood of default in NCDs on July 08, 2020, owing to the severe constrains in the operational cashflows ZLL is facing as a result of the government regulation not permitting the collection of school fee during the lockdown period.

Impact on the investors in the scheme

UTI MF has frozen subscriptions and redemptions in the said schemes until it gets the trustees' approval to segregate the exposure. After the creation of a segregated portfolio, investors will be allotted proportional number of units as in the main portfolio, however, subscription or redemption will not be allowed.

The respective funds will look to list units of the segregated portfolio on a recognized stock exchange within 10 days of segregation. Any recovery from ZLL will be distributed to investors in proportion to their holdings in the segregated portfolio.

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UTI Credit risk in particular has been in the news for all the wrong reasons since last year. The fund's NAV has declined by around 33% during this period; meaning investors lost more than they earned from the scheme.

In the past, the fund had created side pockets for its exposure in Vodafone-Idea (VIL) and Altico Capital following rating downgrades. Notably, UTI had the highest exposure among mutual funds to the downgraded papers of VIL. Furthermore, the fund had to mark-down its entire exposure to DHFL completely, considering the high level of uncertainty regarding recovery timelines and value.

UTI Medium Term Fund has created a side-pocket for its exposure to VIL debt. The fund has witnessed no growth in NAV in the last one year.

Scary times ahead for debt fund investors?

Rating agencies have raised a red flag over the rising stress in corporate debt, mainly in the private sector. India Ratings and Research (Ind-Ra) has anticipated that the COVID-19 impact would turn Rs 2.54 lakh crore of debt into stressed assets.

In the worst-case scenario, where funding markets continue to exhibit heightened risk aversion, corporate stress from the top-500 debt-heavy private sector borrowers could increase by an additional Rs 1.67 lakh crore.

[Read: Why Investing In Debt Mutual Funds Turning Riskier]

Ind-Ra further stated, "Given that 11.57% of the outstanding debt is already stressed, the proportion of stressed debt is likely to increase to 18.21% of the outstanding quantum."

Consequently, low rated issuers will face greater risk leading to a steep rise in rating downgrades. For investors in debt funds, it means that there could be more instances of mark-down in the value of assets and a growing number of segregated portfolios. The trend would be most prominent in funds undertaking higher credit risk.

However, on the brighter side, SEBI has laid down guidelines that will allow mutual funds to sell debt papers, which have defaulted to distressed funds. At present, the stock exchanges suspend trading and reporting of trades on debt securities before the redemption date.

With effect from July 01, the restrictions on transactions in such debt securities can be lifted within two days of intimation of the default from the issuer or debenture trustee. The securities have to mandatorily disclose that there was a default in payment of debt obligations.

SEBI had also asked rating agencies not to consider a delay as default if it was solely on account of the lockdown or because of procedural delays in availing of the moratorium allowed by RBI.

How to approach debt funds now

Invest in debt funds that have predominant exposure to government bonds or quasi-government papers because these can offer better safety and liquidity. For example, Banking & PSU Debt Funds that hold 85 to 90% of its assets in instruments issued by major Banks and PSUs can be considered. Likewise, a Dynamic Bond Fund, which invests only in government securities and a few selected PSUs, can be selected.

To select a scheme, essentially assess your risk appetite and investment time horizon, plus factors such as:

  • The portfolio characteristics of the debt schemes

  • The average maturity profile

  • The corpus & expense ratio of the scheme

  • The rolling returns

  • The risk ratios

  • The interest rate cycle

  • The investment processes & systems at the fund house

In the current scenario where interest rates seem almost bottomed out, you would do better going with low duration funds such as pure Liquid Fund and/or an Overnight Fund that does not have high exposure to private issuers.

At PersonalFN, we arrive at top rated funds using our SMART Score Model. If you wish to select worthy mutual fund schemes, I recommend you to subscribe to PersonalFN's unbiased premium research service, FundSelect.

Additionally, as a bonus, you get access to PersonalFN's popular debt mutual fund service, DebtSelect.

If you are serious about investing in a rewarding mutual fund scheme, Subscribe now!

Warm Regards,
Divya Grover
Research Analyst

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