Institution-promoted mutual funds are facing a problem with the rising downgrades of debt papers which leaves them with very little investment option as there is a bar on investing in unlisted securities issued by associate companies or group companies of their sponsors.
Due to the Securities and Exchange Board of India's rule that an arms length relationship should be kept in case of investments by companies in papers issued by companies under the same directorship or even those which can qualify as `associate' companies, mutual funds are finding that their investment avenues are shrinking.
For instance, ICICI Ltd, by virtue of substantial shareholdings in many corporate entities has its nominee directors on their boards. At the same time it is also a sponsor of Prudential ICICI Asset Management Company which manages the assets of Pru-ICICI Mutual Fund. Due to the conflict of interest clause, the fund is unable to invest in debenture issues issued by these companies.
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Similar is the case with HDFC Mutual Fund where chairman Deepak Parekh, who is on the board of the asset management company, is also on the board of a number of leading corporates. Other funds such as IDBI MF and LIC MF are learnt to be facing the same problem since their parent organisations that is IDBI and LIC have nominees on corporate boards due to their considerable stakeholding in these companies. GIC MF is exempt since it does not have an income fund and so does not invest in such securities.
Under the mutual fund Regulations "No scheme shall make any investment in any unlisted security of an associate or group company of the sponsor or any security issued by way of private placement by an associate or group company of the sponsor". This encompasses unlisted debenture issues frequently issued by corporates.
This is where the pinch is. While Sebi's reasoning is that an arms' length relationship should be maintained in any investments made in order to avoid conflict of interest mutual funds complain, "unlisted debenture issues are typically private placements and these are actually lucrative instruments of investment for funds," but the strict guidelines imposed by Sebi practically debar these companies from subscribing to these issues.
The problem has become compounded in recent times as rating agencies have been rampantly downgrading debt issuances of second-rung corporates. This leaves only top notch corporates and mutual funds have to helplessly stand by when they issue debentures and they cannot invest in it. A fund manager in Pru-ICICI MF shrugged it off philosiphically saying "these things happen."
In fact most of the funds have send informal feelers to Sebi officials regarding it but no concerted action under the Association of Mutual Funds of India has been initiated. However under the current circumstances funds, though on an individual basis, have decided to appeal to Sebi, to relax the rules.