In a recent circular issued last week, SEBI has further tightened norms regulating liquid funds. The market regulator said that liquid funds have to hold at least 20% of its net assets in liquid assets, effective April 1, 2020.
Here ‘liquid assets’ include cash, government securities, T-bills and repo on government securities.
The objective is to improve credit quality and enhance ability of liquid funds to meet redemption pressure. Nevertheless, experts feel that these measures could also lead to a 10-50 bps decline in returns generated by liquid funds.
Dwijendra Srivastava, CIO – Debt, Sundaram MF said, “Currently liquid funds of most big fund houses hold only 5-10% of their portfolio in the defined ‘liquid assets’. Now that they will have to rejig the portfolio, returns of liquid funds will certainly come down.”
Mahendra Jajoo, Head-Fixed Income, Mirae Asset MF said that the decline in returns of liquid funds could fall by as much as 50 bps, subject to market conditions.
Jajoo explained this with an example of a liquid fund that holds 0% ‘liquid assets’. Once the fund manager has to invest 20% in ‘liquid assets, he will have to rejig the scheme’s portfolio by taking out 20% of its commercial papers and replace it with T-bills. If the difference in spread of T-bill and commercial papers is 100 bps, return of that liquid fund will decline by 20 bps (20% of 100 bps), he said.
The circular also introduced two new measures that came into effect immediately; firstly, liquid funds and overnight funds can no longer park their corpus in short term deposits of scheduled commercial banks. Secondly, these schemes cannot invest in debt securities having structured obligations (SO rating) and credit enhancements (CE rating) as well. However, debt securities with government guarantee are excluded from such restriction.
MF Researcher Vidya Bala feels that all these measures may bring down returns of these funds. However, this should not be a cause for worry. These measures prevent these schemes from taking credit risk and make them safer. Anyone who is investing in these categories should be more concerned about capital preservation rather than a few basis points of higher return, she added.