Case 038Liquidity, redemptions and stressCore
A Rs 400 crore fixed maturity plan matures next month, but a Rs 45 crore bond in it has missed a payment and is valued at 25% of face. What do investors receive at maturity, what happens to the unpaid bond, and what should the AMC tell investors now?
1The situation
Gauravi Mutual Fund launched a three-year fixed maturity plan, a close-ended debt scheme, that now holds bonds worth Rs 400 crore at face including accrued interest, spread across 32 crore units, about Rs 12.50 a unit. It matures next month, when every bond in it is due to repay.
One issuer, whose bonds make up Rs 45 crore of face value, has missed an interest payment. The valuation agencies now mark the bond at 25% of face, Rs 11.25 crore. Gauravi's scheme documents allow it to create a segregated portfolio after a credit event. Investors have started calling distributors.
2Your task
What do investors receive at maturity, what happens to the defaulted bond, and what should the AMC say to investors now?
Quick check
Per unit, roughly what do investors receive in cash at maturity if the AMC segregates the bond?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
Investors receive about Rs 11.09 a unit in cash at maturity from the Rs 355 crore of performing bonds, and keep a separate claim on the defaulted bond, valued today at about Rs 0.35 a unit. Together that is Rs 11.45 against Rs 12.50 expected. The segregated units pay out only as the issuer pays. The AMC should tell investors now: what happened, the numbers, the process and that recovery is uncertain.
Step 1Why can't a closed scheme just wait out the default?
If a family fixed deposit at one bank is frozen while the others mature, you collect the ones that matured and keep chasing the frozen one; you do not refuse all your money until the frozen one is settled. A fixed maturity plan has to pay out on its date, so the defaulted bond has to be separated from the bonds that did repay. The tool is a segregated portfolioA side pocket created after a credit event: the troubled bond moves into a separate portfolio, and every existing investor gets units in it in proportion to their holding., which SEBI permits under conditions set in the scheme documents; confirm the current rules on when it may be created.
Run the numbers. The scheme was worth Rs 400 crore with every bond at face, Rs 12.50 a unit. Take out the defaulted bond's Rs 45 crore and Rs 355 crore of performing bonds remain; when they repay, investors receive Rs 355 crore over 32 crore units, Rs 11.09 a unit. The segregated portfolio holds a Rs 45 crore claim marked at 25%, Rs 11.25 crore, about Rs 0.35 a unit.
Step 2What could investors eventually get from the bad bond?
The 25% mark is a valuation, not a promise. If the issuer eventually pays nothing, investors end with Rs 355 crore; at a 40% recovery, Rs 373 crore; if the issuer recovers fully, the full Rs 400 crore. Segregation's value is fairness: the recovery goes to the investors who held the scheme on the day of the credit event, not to anyone who trades the units later, and the performing money is not held hostage to a recovery process that may take years.
| Eventual recovery on the defaulted bond | Total to investors, Rs crore | Per unit, Rs |
|---|---|---|
| 0% | 355.00 | 11.094 |
| 25% | 366.25 | 11.445 |
| 40% | 373.00 | 11.656 |
| 100% | 400.00 | 12.500 |
Step 3What should the AMC tell investors now, and what should it ask itself?
Write to every investor before maturity, in plain words: which issuer, what was missed, the valuation agencies' 25% mark, the expected maturity payout of about Rs 11.09 a unit, the segregated units they will hold, and how and when recoveries will be distributed. Never imply a recovery figure or a date the AMC cannot control. Then the inward questions: the bond was 11.25% of the scheme, so check it against the single-issuer limit that applied when it was bought (confirm the current SEBI limit), and review why the credit team kept it as the issuer weakened. Segregation protects investors from timing unfairness, not from a poor credit call.
Where candidates lose it
The common loss is answering that investors get Rs 366 crore, the marked-down value, in cash. The 25% mark is not money; the defaulted bond pays nothing until the issuer does, so the cash at maturity is only the performing Rs 355 crore.
The second miss is suggesting the AMC extend the scheme until the default resolves. Rolling over a closed scheme needs investor consent and holds back money that has already been repaid.
What the interviewer asks next
- The issuer offers a settlement of 35% paid over two years. How should the AMC decide whether to accept?
- Should the segregated units be listed on an exchange? Who benefits?
- How would you explain the segregated units to a retail investor in two sentences?
Company names and figures are illustrative.