Indian Liquid Funds "break the buck"

2 comments Written on October 14th, 2008 by
Categories: Crisis2008
From Value Research Online: Reserve Bank comes to the support of Cash Funds:
RBI has decided to provide a temporary credit line to funds to enable them to bridge the gap between redemption requests and the sale of underlying securities. The move comes in the shape of a special Rs 20,000 crore credit line to banks which is to be used to provide 14-day credit to funds. The central bank will conduct a special 14 day repo at 9 per cent per annum for the notified amount of Rs.20,000 crore.

Last Friday, something unprecedented happened-some mutual funds of the 'Liquid Plus' type made a loss over the previous day, i.e., their NAVs for Friday were actually lower than their NAVs for the Wednesday, the previous day when the markets were open. The number of funds affected were not large-in all about five funds out of 36 showed a loss. These losses are important for two reasons. One, this type of funds is supposed to be an ultra-safe one that shouldn't have any losses ever. And two, this could well be the harbinger of a deeper problem that could become serious over the next few days. In the coming days, perhaps as early as Monday, the same problems could hit cash funds and perhaps some other debt categories also.

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Over the last few days, it appears that fund companies have had trouble making redemptions because the underlying instruments are becoming difficult to sell. The deep risk aversion and credit worries that have gripped financial markets have meant that debt assets that should have been easy to sell have proven near impossible to sell. On Friday, a few fund companies seem to have honoured redemptions by selling some investments at whatever price they could get. This price was obviously lower than what the instruments were valued at. As a result, NAV has dropped and the funds' investors have borne losses. The losses may look tiny to equity investors but they are a big deal for liquid funds. The root cause is that liquid funds were being bought under the assumption that their risks were negligible. However, negligible does not mean zero.

Liquid "plus" funds losing NAV? Where did I hear that last? Uhem - here it is. November 2007: GE's "enhanced" cash fund breaks the buck. The credit crisis took ten months from then, to really hurt. When is ours coming?
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The man behind Capital Mind. Deepak is a co-founder at MarketVision, a financial knowledge company. Deepak also provides data research and consulting services, and now lives in Bangalore. Connect with him at deepakshenoy@gmail.com.

2 comments “Indian Liquid Funds "break the buck"”

>Borrow short and lend long. This principle is OK for Medium Term Funds. But for Liquid funds this means big trouble.

Unfortunately Indian MF fund managers got carried away by this prevailing International craze. At least one saving grace they did not leverage (like Hedge Funds).

Anyway the situation will resolve itself. Some of the MFs are arms of FIIs who can give them liquidity. Others can sell assets (CDs and CPs) at market price and those Naked MFs can come begging to RBI/Banks to give them support.

It may not surprise if the Fund Managers got personal incentives to go Long with CDs and CPs.

>Liquid Plus against Liquid Funds

Liquid Plus funds were launched to cater to those with a stomach for slightly higher risk, and as a result higher returns. A typical liquid-plus fund will have similar investments like a liquid fund, but around 30 per cent of the corpus is invested in instruments with longer maturity period.

They do not have any restriction on the mark-to-market component (liquid funds can have only up to 10 per cent) and there is no lock-in period for the liquid-plus funds category. Also, liquid-plus funds are a hit as they are more tax-efficient. The dividend distribution tax works out to 14.16 per cent as against 28.33 per cent for liquid funds.

As the tax treatment of liquid-plus funds is better, they would still outperform, considering the net-of-tax parameter. This is why retail investors can consider this as a more sensible option, albeit at higher risk, to invest their money in the short term.

Visit – http://www.sundarambnpparibas.in/Liquid_plus/


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