How the HDFC-HDFC Bank Merger Will Impact Equity Mutual Fund Holdings

The HDFC-HDFC Bank merger is set to conclude in the coming weeks. As you may be aware, in April 2022, housing finance major HDFC Ltd. had announced its merger into its subsidiary HDFC Bank, India's largest private sector lender.

For every 25 shares of HDFC Ltd., the shareholders will receive 42 shares of HDFC Bank. In other words, shares held in HDFC Ltd. will get cancelled and HDFC Ltd. will own 41% of HDFC Bank.

The merged entity will be known as HDFC Bank. Once the merger concludes, HDFC Bank's share price will be adjusted to incorporate the value of HDFC Ltd.

Since HDFC Bank and HDFC Ltd. are among the largest and fastest-growing entities, equity mutual funds have invested heavily in these two entities. For many years, HDFC and HDFC Bank, often referred to as 'HDFC Twins', have been part of the core portfolio of several actively managed equity mutual funds, particularly Large Cap Funds. These stocks have been multibaggers and so it is no surprise that for many actively managed mutual fund schemes, the combined allocation in these two entities is beyond 10%.

Join Now: PersonalFN is now on Telegram. Join FREE Today to get 'Daily Wealth Letter' and Exclusive Updates on Mutual Funds

It is important to note that the merger will take their holding in one security to above 10% for such schemes. This is particularly true for some actively managed Large Cap Funds, ELSS, Value Funds, Flexi Cap Funds, and Focused Funds. However, SEBI rules mandate that actively managed equity mutual funds should restrict their holding in an individual security to 10% of assets under management (AUM). Media reports suggest that SEBI is unlikely to give special exemption to mutual funds if they breach the 10% threshold (the maximum permitted holdings in a particular security) after the merger of HDFC Bank and HDFC Ltd.

This limit does not apply to Sector/Thematic Funds as well as passive funds such as Index Funds and ETFs.

The comply with SEBI regulations, equity mutual funds will have to bring the exposure in the merged entity to 10% or below. Mutual Funds can do so by selling the shares in the open market. They also have the option to transfer some shares to another scheme within the same fund house.

SEBI will likely consider this as a 'passive breach' rather than a deliberate attempt to breach the regulatory threshold. Thus, mutual funds will have 30 days to adjust/rebalance their portfolios once the merger concludes.

In terms of value, Mirae Asset Large Cap Fund has the highest excess exposure of around Rs 1,227 crore, followed by HDFC Top 100 Fund and Axis Bluechip Fund, having excess exposure of Rs 707 crore and Rs 455 crore, respectively.

The data also shows that in terms of exposure as a percentage of AUM, Invesco India Tax Plan's combined exposure to HDFC Bank and HDFC Ltd. currently exceeds the 10% mark by nearly 5 percentage points. Likewise, Bandhan Large Cap Fund, Tata Equity P/E Fund, Invesco India Large Cap Fund, and Sundaram Large Cap Fund are among the 30-odd diversified equity mutual funds whose combined exposure overshoots the 10% mark.

Rough estimates suggest that mutual funds will have to offload/transfer shares worth Rs 4,500 crore. The shares of HDFC Bank/HDFC Ltd. are highly liquid, and therefore offloading the shares will not be an issue for mutual fund houses. However, the shares may witness some volatility in the near term as fund managers and other investors adjust their holdings.

Some mutual fund houses/schemes have already begun trimming their exposure in the two entities ahead of the merger.

Overall, the merger of HDFC Bank and HDFC Ltd. may not be disruptive for investors in mutual fund schemes that hold high exposure to these stocks.

As a result of the merger, there will also be a shift in control at HDFC AMC from HDFC Ltd. to HDFC Bank. This too is not expected to have any impact on the day-to-day operations of HDFC AMC as the fund house has a strong team of skilled and experienced fund managers who will continue to be at the helm of the schemes. Read more about it here.

Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.

Disclaimer: This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision.