SEBI’s recent circular on restrictions on both valuations and holdings of perpetual bonds by mutual funds has created a storm – not just among the fund manager community but all the way up to the Ministry of Finance.
The circular on perpetual bonds
The circular, broadly, states the following:
- A mutual fund scheme cannot hold more than 5% of its assets in a perpetual bond issued by a single issuer. It cannot hold more than 10% of its total AUM in perpetual bonds in a single scheme.
- No AMC can own more than 10% of the perpetual bond issued by an issuer.
- Closed-end funds shall not invest in perpetual bonds.
- The maturity of all perpetual bonds shall be treated as 100 years from the date of issuance of the bond for the purpose of valuation. Currently, MFs follow the call/put option date to value the yield.
The circular shall be made effective April 1, 2021.
What the circular means
The circular, if applied, shall mean 2 things:
- Many funds will not be able to hold such a perpetual bond if their mandate restricts them. For eg. An ultra-short-term fund can’t meaningfully hold such an instrument.
- Funds may need to revalue the bonds, and this can lead to mark-to-market losses as yields will be marked up if one considers the date of maturity as 10 years as opposed to 2-3 years.
Funds across the spectrum hold these funds. Banking & PSU debt funds, Low duration funds and balanced advantage/dynamic asset allocation funds are among the larger holders of this instrument. We will put out a more detailed report on fund holdings, if this circular remains.
It is noteworthy that, AMFI, in a response to this circular, has stated that the ‘100-year valuation’ will apply only if there is no traded value to the instrument. Now, this may provide some respite.
But here’s the bouncer. Media reports quote a communication from The Ministry of Finance (MoF) to SEBI – raising concerns about this proposal and the possible panic selling. It has also stated that perpetual bonds are used for bank’s capital needs and requested that the revised circular on valuation of perpetual bonds be withdrawn.
This being the case, we will wait for clarity on what is to happen before we write about it for you. As of now, restraining mutual funds from taking exposure to a highly risky category like perpetual bonds is a good move. However, the valuation norm, at an extreme 100 years, can cause impact on your NAVs. We’ll keep you posted.