An Indian 2,000 rupee banknote is arranged for a photograph in Bangkok, Thailand. (Photographer: Brent Lewin/Bloomberg)

Prepare For Lower Returns From Liquid Funds

As the market regulator looks to protect mutual fund investors from IL&FS-like default risks, debt schemes widely used by companies to park short-term cash are expected to turn less lucrative.

Liquid funds with a maturity of more than 30 days will have to mark-to-market the value of the assets they manage, according to a statement uploaded on the Securities and Exchange Board of India website after its March 1 board meeting. Earlier, schemes with a maturity of up to 60 days were exempted.

“Fund managers don’t want volatility. So instead of running mark-to-market risk, they will reduce maturity profile,” R Sivakumar, head, fixed income at Axis Mutual Fund, tweeted. The turnover will rise and the implication for corporate sector is large, he said. “Their CP (commercial paper) funding risk will rise both in terms of uncertainty of amount and yield as they will have to roll over the CPs 12 times a year instead of six times.”

Along with this, Sivakumar said a “new transaction tax” of 1 basis point on money-market instruments will increase costs. This stems from a 0.005 percent stamp duty each on issuance and sale of debt securities except debentures—announced in the budget.

Assuming all new purchases are of 30-day maturity, Sivakumar expects an impact of 12 basis points on the yield. But in reality, not all new purchases will be for 30 days, and therefore the yield impact will be more, he said. “This is not accounting for brokerage and other transaction costs, all of which lead to higher costs/lower returns.”

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Liquid funds invest in debt paper with up to 91 days of maturity and are considered less risk and offer higher returns than fixed deposits. Typically, securities with a maturity of 60 days and higher offer better returns than those with a tenor of 30 days. SEBI’s tighter rules for such plans come after defaults by AAA-rated Infrastructure Leasing & Financial Services led to redemptions because of a liquidity crunch. Mutual funds themselves had to write off the value of investments in the IL&FS entities downgraded to default.

The regulator’s move to enforce mark-to-market valuation will lead to increase in yield for papers with maturity between 31 and 60 days, according to Kirtan Shah, chief financial planner at Sykes & Ray Equities (I) Ltd. It will also lead to higher fund turnover and the tax on the money market too has been increased by 1 basis point on each transaction. “All this should ideally lead to fall in liquid funds returns.”

Amol Joshi of PlanRupee expects the move to reflect market valuation realities despite slightly lower returns. “All things remaining constant, the liquid fund NAVs will be (more) volatile than what the current experience is,” he said. To avoid this, the funds will increasingly concentrate around below 30-day securities, putting pressure on their returns, he said.

Largely companies invest in liquid funds. Vijai Mantri, founder and chief investment strategist at JRL Capital, said the change in amortisation rules will make such schemes favourable for retail investors and reduce the arbitrage opportunity for corporate investors. It will reflect a more realistic, market-linked returns picture, he said, and “enhance transparency in the way securities are being valued”.

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