Just like equity funds, liquid funds would become more volatile going forward. SEBI has proposed to introduce mark-to-market valuation for all debt securities, irrespective of their maturity.
A few months back, SEBI had directed fund houses to do mark-to-market valuation of debt securities having maturity of less than 30 days (reduced from the earlier 60 days). However, SEBI has proposed to do away with such maturities to reduce risks in liquid funds.
Debt market analysts feel that if fund houses have do mark-to-market valuations of all securities on a daily basis, liquid funds would start reflecting negative returns frequently.
Kirtan Shah, COO, StreetsAhead said that SEBI’s move would reduce risk in debt funds to some extent. Since there is no amortization, fund managers would not take undue risks to deliver attractive performance in liquid funds. Most fund managers buy short term corporate bonds which carry high credit default risk to generate better returns, he said.
Shah, however, believes that fund managers would increasingly concentrate on debt instrument having maturity of at least up to 30 days to outperform overnight funds.
Seconding Shah’s view, Joydeep Sen, debt analyst said that though liquid funds would become more volatile, the modified duration on the security, which is an indicator of volatility is much lower i.e. impact would not be huge.
The proposed changes has come after the recent credit events in the fixed income market that led to a sharp fall in NAVs of several debt funds.
Here are other proposed changes in debt funds
- Cap on sectoral limit reduced to 20% from 25% to mitigate concentration risk
- Additional exposure given to HFCs and affordable housing loans reduced to 10% and 5%, respectively. In 2017, the SEBI increased the additional exposure limit for debt funds into HFCs to support funding for the affordable housing segment. However, many HFCs have increased their lending to real estate companies, which has exposed MF investors to higher risk
- Debt funds can only invest in listed NCDs
- Incremental investments in Commercial Papers (CPs) have to be only in the listed ones
- In case of investment in loans against shares, fund houses will have to maintain at least 4 times cover for such investments. For instance, debt funds can lend Rs.100 crore after pledging shares worth Rs.400 crore
Proposed changes specific to liquid funds
- At least 20% of liquid fund holdings has be kept in safer instruments like cash, government securities and T-bills. This will help liquid funds deal with redemption pressure
- Liquid schemes and overnight schemes cannot invest in short-term deposits and money market instruments having structured obligations such as retail loans backed by a lender or credit enhancements like loan against shares. Even today, liquid funds and overnight funds do not have exposure to such instruments
- Mutual funds can levy graded exit load on investors of liquid schemes, who exit the scheme within 7 days. That means SEBI will allow fund houses to impose exit loans in liquid funds to the extent of 7 days; however, such loads will be reduced with the increase in days. Simply put, investors redeeming after a day will have to pay more exit load than the investors redeeming it on seventh day
On proposal of introducing exit load in liquid funds, Sen said that this would go against the grain of the product. “Liquid fund is a cash management product. Hence, exit loads is undesirable.”
