JP Morgan Mutual Fund has worked out an innovative solution to the problems afflicting two of its debt funds
14-Sep-2015 •Research Desk
To return liquidity to its two problem funds, JP Morgan Mutual Fund has proposed to split the two funds into separate portions. One portion will just have the problem bond, and the other with the rest of the portfolio, which is perfectly liquid. Each part will have a separate NAV. Hopefully, this will enable the healthy part of the portfolio to be liquid and redeemable. Of course, as per the rules, this arrangement has to be first approved by investors through a postal ballot. The process should be complete by the end of September.
Debt fund investors will recall that some three weeks ago, two of JP Morgan's debt funds (JPMorgan India Short Term Income Fund and JPMorgan India Treasury Fund) were hit with a asset quality crisis. Both portfolios had bonds issued by the NCR-based Amtek Auto were pushed below investment grade by their rating agency, Brickwork.
Consequently, as per the valuation norms, these bonds dropped sharply in value leading to a sharp and sudden decline in NAV which investors in such funds don't expect. To prevent a run on the funds, the AMC imposed a redemption limit on the funds from August 28th onwards. Now, it has come up with this scheme of separating out Amtek Auto from the funds so that the remaining portion of the two funds can function normally and the redemptions restrictions can be lifted.
This is an innovative solution that the AMC has come up with, and it should enable a vast majority of the investors' currently frozen money to be made available. Moreover, given that such a problem can occur to any AMC's funds in the future (hopefully, rarely), it's a good model for a solution.
The arithmetic of the split is simple. Amtek Auto's bonds form seven per cent of the pre-split value of the fund, and the rest 93 per cent. If the split goes through, investors can redeem 93 paisa out of every pre-split rupee whenever they want. The remaining seven paisa will have to wait for the Amtek Auto bond to become clearer.
JP Morgan has made the NAV and unit calculations needlessly complicated by starting off the Amtek part with a ₹10 NAV. However, to understand what happens to their money, investors should treat this as a straightforward 93:7 division of the value of their investments.
The root cause of such problems is that the Indian fund industry runs open-ended debt funds with near-immediate liquidity while being invested in relatively illiquid bonds. And that too in an economy which has a barely functional market for corporate bonds. That's a problem that's not going away soon.