RBI Steps in to Take Some Pain Off Mutual Funds. Will It Help?
Listen to RBI Steps in to Take Some Pain Off Mutual Funds. Will It Help?
00:00
00:00
Last week the mutual fund industry was jolted by the news of Franklin Templeton MF winding down six of its debt schemes. The fund houses cited high redemption pressure and lack of liquidity due to COVID-19 as the reason behind the move.
There has been a rush of redemption in the debt market due to high volatility and uncertainty caused by the outbreak of pandemic. The stress is more evident in high-risk category of securities where liquidity has dried up. Notably, the schemes that were wound up belonged to the high credit risk category.
The recent FTMF fiasco led RBI to take note of the situation and step up to build confidence in the capital market.
On April 27, 2020, RBI announced the opening of a special liquidity facility (SLF-MF) worth Rs 50,000 crore to ease liquidity pressure on mutual funds.
Under SLF-MF, RBI will conduct repo operation of 90 days tenor at the fixed repo rate. Banks can avail funds under this facility between April 27, 2020 and May 11, 2020 or up to utilization of the allocated amount, whichever is earlier. RBI will review the timeline and amount, depending upon market conditions.
Banks have to utilise the funds availed under this exclusively for meeting the liquidity requirements of MFs by:
-
Extending loans, and
-
Undertaking outright purchase of and/or repos against the collateral of investment grade corporate bonds, commercial papers (CPs), debentures and certificates of Deposit (CDs) held by MFs.
The liquidity support under this would be eligible to be classified as held to maturity (HTM) even if it goes beyond the 25% limit of total investment in the HTM portfolio.
photo created by mindandi - www.freepik.com
Will banks come to the aid?
For banks, availing funds at a lower rate (repo rate) and using it to purchase investment grade, which generally carry higher interest, and holding them till maturity seems like a good opportunity, but they may not be as enthusiastic to come to the aid of MFs.
You may recall that few days ago, RBI came out with a similar liquidity window worth Rs 50,000 for NBFCs. Of these, 50% of funds had to be dedicated towards investment in investment grade bonds, commercial paper, and non-convertible debentures small and mid-sized NBFCs and MFIs.
NBFCs who have been dealing with liquidity crunch for quite some time now is one of the worst affected sectors with rising risk of bad loans amid the COVID-19 outbreak.
As a result, the first tranche of the operation worth Rs 25,000 crore conducted few days ago received bids for just Rs 12,850 crore.
Similarly, the stress in debt mutual fund segment is not new - some categories of debt funds have been facing redemption pressure ever since the IL&FS debacle came to light. Banks may be reluctant to lend to mutual funds with higher exposure to lower quality papers, which have been lacking in liquidity.
If banks do lend to MFs it may be limited to those with good quality papers. This will not serve the intended purpose of the facility.
Many mutual funds investing in credit-risk grade securities may have offloaded good quality papers to meet the high redemption and may be now left with only lower quality papers. Risk aversion in banks has magnified due to rising fear of bad loan pile up. Hence, banks may not be keen to accept lower quality papers as collateral.
Besides, some mutual funds may already have high borrowing rate availed to fund redemptions and further borrowing may not be a viable option for them.
Thus, if redemption pressure continues, liquidity strain will continue in schemes carrying higher exposure to lower rated securities. Hence, RBI may have to come out with alternative steps to deal with issue that would infuse liquidity directly to mutual funds rather than relying on banks.
Word of caution for investors in debt funds
RBI and AMFI have assured investors that stress in capital market is confined to the high-risk debt MF segment at this stage; the larger industry remains liquid.
In the current market volatile and uncertain environment, it would be advisable to stay away from credit risk schemes. However, do not resort to panic selling. Doing that will have an exponentially negative effect on funds, primarily those having exposure to moderate and low rated assets.
Redemption pressure may force the fund managers to sell good quality papers in the portfolio in the secondary market and pile up exposure to low rated assets because it will be difficult to liquidate at fair value.
Keep in mind that debt funds are not risk-free. Investment in debt funds carry various risks relating to liquidity, credit quality, and interest rate. Therefore, before investing in debt funds understand the various risks involved and invest in schemes where the portfolio risk aligns with your own risk appetite and financial objective.
Moreover, choose a fund house that follows prudent investment process and stringent risk-management systems.
In these uncertain times, it would be wise to stick with liquid funds and overnight funds for the debt part of your portfolio as they are highly liquid and carry lower risk.
Our friends at Quantum Mutual Fund have highlighted the secret behind their debt management strategy, which has helped them provide safety and liquidity to investors when it comes to investing in quantum funds. Don't Worry, Quantum Liquid Fund always aims for Safety and Liquidity.
PS: If you wish to select worthy mutual fund schemes, I recommend you to subscribe to PersonalFN's unbiased premium research service, FundSelect.
Additionally, as a bonus, you get access to PersonalFN's popular debt mutual fund service, DebtSelect.
If you are serious about investing in a rewarding mutual fund scheme, Subscribe now!
Warm Regards,
Divya Grover
Research Analyst
Join Now: PersonalFN is now on Telegram. Join FREE Today to get ‘Daily Wealth Letter’ and Exclusive Updates on Mutual Funds