Come April 1, 2020, liquid funds will become more volatile and at the same time safer. In its latest guidelines, SEBI has introduced new valuation metrics to be followed by AMCs.
Among the key changes is the introduction of mark-to-market valuation for all debt securities, irrespective of their maturity. The market regulator has asked fund houses to follow waterfall approach for valuation of money market and debt securities irrespective of their maturity.
Currently, credit rating agencies follow waterfall valuation approach for debt securities having maturity of over 30 days. Under this approach, while rating agencies consider 1-hour trading volume to arrive at valuation of government securities like g-sec and T-bills, they take into account the trading volume of entire day to arrive at valuation of other debt papers like CPs and CDs. Once they arrive at these valuations, they send the weightef average price of these securities along with the last traded price of these securities to a polling team, which has 25 members from various institutions including banks, mutual funds, insurance and pension funds. Based on the poll, rating agencies decide if a security is valued at weighted average price or its last traded price.
Now with the latest regulations, fund houses will have to follow this approach for securities having maturity of less than 30 days too.
Currently, fund houses broadly follow three metrics to arrive at NAV in a liquid fund
- For a portion of portfolio having exposure to government bonds like g-sec, treasure bills or state development loans (SDLs), the fund house has to rely on credit ratings agencies
- For repo, tri party repo (TREPS) and short term deposits, the fund house has to follow internal valuation metrics i.e. amortization based valuation i.e. average yield of such securities divided by 360
- For other securities like derivatives, CPs, CDs and market linked debentures (MLDs), fund houses have two options – a. amortization based valuation and b. follow valuations given by rating agencies. However, the difference between traded price (amortization based valuation) and price quoted by rating agencies of a security should not exceed 0.025%
However, from April 1, 2020, while the first two clauses remain unchanged, fund houses having exposure to other securities like derivatives, CPs, CDs and MLDs in their liquid funds will have to follow rates or price quoted by rating agencies. This essentially means that liquid fund returns would go down by 5-7 bps as there will be no amortization method to arrive at valuation, said Kirtan Shah, COO, StreetsAhead. He further said that fund managers would not take undue risks to deliver attractive performance in liquid funds. Kirtan believes that fund managers will now increase average maturity in liquid funds from 30 days to 45-50 days to outperform overnight funds.
Other key changes announced by SEBI are
- Fund houses will have to upload NAV of all schemes by 11 pm. Currently, the cut off time to upload NAV is 8 pm
- Below investment grade would be securities having long term rating of below BBB- or short term rating of below A3
- A security will be termed default if it fails to oblige principal or interest payment on time
- Fund houses will have to declare their exposure to below investment grade papers
- Inter scheme transfers (ISTs) will be allowed only if AMCs seek prices of IST from valuation agencies subject to a specific turnaround time
