Last week, SEBI has banned Kotak Mahindra AMC from launching new fixed maturity plan (FMP) schemes for the next six months and also imposed a penalty of ₹50 lakhs on the AMC
Kotak Mutual Fund has been one of the most reputed AMCs in the industry. So naturally, it comes as a shock that the fund house failed to pay maturity proceeds to unitholders on time because some of their FMPs invested the money in dubious companies of the ailing Essel group. According to SEBI’s order, “Kotak AMC did not pay investors full proceeds based on the declared Net Asset Value (NAV) of the schemes on their respective maturity dates”.
Between April-May 2019, six FMPs of Kotak Mutual Fund, with a total AUM of ₹2,092 crores, were due for maturity. But on the maturity date, the AMC repaid only ₹1,740 crores from the total amount. Although later in September 2019, the fund house repaid the balance amount to investors along with interest. However, in doing so Kotak AMC violated certain provisions of the Mutual Fund Regulation. According to SEBI, Kotak AMC also violated other provisions such as lack of proper due diligence in investing in the companies in question, failure to keep investors informed sufficiently in advance, violation of norms for segregation of portfolio, and wrong method of valuation of securities.
What went wrong?
The six FMP schemes had invested in zero-coupon non-convertible debentures (ZCNCDs) of Konti Infrapower & Multiventures Pvt Ltd and Edison Utility Works Pvt Ltd. Both the companies were insignificant and financially handicapped entities of Essel Group. The debentures were secured by a pledge of equity shares of Zee Entertainment Enterprises Ltd.
In 2019, Essel Group went through a debt crisis. As a result, the above companies could not meet the repayment in full.
Kotak Mahindra AMC tried to insulate itself from the credit risk by accepting collateral in the form of pledged shares of ZEEL, but when required, the value of these shares fell short of the stipulated collateral cover.
Kotak Mahindra AMC extended the maturity of those NCDs beyond the maturity dates of the FMP schemes, thereby postponing the redemption of the units corresponding to those instruments, violating regulatory provisions governing the management of close-ended funds.
Here are some of the wrongdoings of Kotak AMC
- showed lack of due diligence and proper care,
- failure to consider research report and analyze various factors;
- non-disclosure of adverse information to investors;
- extension of maturity date of NCDs beyond the maturity date of the scheme;
- partial redemption and not winding up FMPs at the end of maturity;
- using wrong method of valuing securities.
The financial markets not only fined Kotak AMC and banned it to issue any new FMPs for the next six months, but they also asked them to refund part of the investment management and advisory fees collected from the unitholders of six FMPs along with simple interest at the rate of 15% per annum.
The AMC should’ve realised that “high reward” is generally concomitant to “high risk”, the regulator said. They also highlighted that FMPs are expected to be conservative schemes and retail investors should not be exposed to the high risk that Kotak took on their schemes with poor-quality investments.
What are FMPs? Are they safe?
For those of you who do not know, FMPs are closed-ended debt funds that aim to provide predictable returns over a fixed period. They invest in fixed income instruments (usually corporate debt) with maturities similar to the mutual fund’s duration. FMPs generally hold the securities till maturity; and thus, the interest rate risk is minimal. They are often regarded as the mutual fund equivalent of fixed deposits (FDs) but offer better tax-adjusted returns due to the indexation benefits they offer.
Theoretically, FMPs are low-risk investment products. But how much risk an FMP investor is actually exposed to depends completely on the portfolio of the fund. Some FMPs take higher risks by investing in below-AAA-grade instruments for extra returns. So, the risk of default or delay in payments in FMP, like in Kotak’s case, does exist.
Another problem with the FMPs is that there is no transparency about the portfolio of the fund, and since it is a closed-ended scheme, you don’t know where your money will be invested until after you’ve committed the funds. While you get some idea about the indicative portfolio quality through the Scheme Information Document (SID), the actual portfolio composition is disclosed only after allotment.