Business
Bread and butter business of fund houses under threat > Floaters lose 2.1% > Short-term bond funds shed 1.96% s> Ultra shorts down 2.06%h
Updated : Mar 17, 2018, 04:56 AM IST
“How did you go bankrupt?” Bill asked.
“Two ways,” Mike said.
“Gradually, and then suddenly.”
— The Sun Also Rises,
Ernest Hemingway
It has been a little over one year since the no-entry load regime kicked in for mutual funds (MFs).
With that, their ability to pay wholesome commissions to agents stood reduced.
The impact of that has been an outflow Rs 8,160 crore from equity mutual funds between August 2009 and June 2010.
What that meant was less assets under management, so lesser fees from managing money and, therefore, lower income.
And that wasn’t enough, funds now have another huge bother.
Following a Securities and Exchange Board of India (Sebi) diktat, a new mark-to-market norm has begun for debt funds from August 2.
Guess the immediate impact: debt fund NAVs got socked.
The average liquid fund daily return on August 2, 2010 (essentially the difference between the net asset value of a scheme on Friday, July 30, 2010 and Monday August 2, 2010) was -1.87%.
The average yearly return on a liquid fund over the last one year has been 3.56%.
In a day, half of that is poof!
In fact, the average daily return of liquid funds over the last one year has been at 0.015%. This also tells us how huge the fall has been.
The situation is the same for other debt mutual funds that invest in short-term financial securities. Floating rate funds lost 2.10% on an average, short-term bond funds lost 1.96% and ultra-short-term bond funds lost 2.06% on a single day.
Sources said the losses would have been even greater but for mutual funds deciding to take a portion of the hit on their books and not passing the whole of it to the scheme.
“Many fundhouses have absorbed the loses. Otherwise the drop would have been higher,” two fund managers said, wishing to be named.
Among these schemes nearly 45% of the assets under management of mutual funds are concentrated. So the bread and butter business of mutual funds is now in danger.
Corporates typically invest their surplus money in these schemes for extremely short periods of time.
They prefer these schemes because they generate a small return and at the same time are more tax efficient than bank deposits. Also these schemes have never been known to give negative returns and are thus as good as bank deposits for short time periods.
So what spoiled the party? The Sebi circular makes it mandatory for debt mutual fund investments in financial securities having a maturity period of greater than 91 days to be marked-to-market. Earlier, only securities with 180 days or more maturity needed to be marked thusly.
Mark to market is the process by which an asset is valued based on its latest market price.
“Most funds have 60-70% of their portfolio in securities that have maturities greater than 91 days, but below one year,” said a financial planner.
The value of a financial security depends on which way the market feels interest rates are headed.
If the market feels interest rates are rising, yields or the returns one can get if one holds on to the security till maturity go up, which leads to the price of the security falling.
When the price of the security falls, the net asset value of the mutual fund goes down. This in turn leads to negative returns.
And that has precisely what happened. Securities with a maturities between 91 and 180 days suddenly got marked down in value because of the rise in yields.
“Yields have gone up so there had to be negative returns. It is a small drop and a one-day drop as it was the transaction period. Now on it will not be as sharp,” said another fund manager, also not willing to be named. “If yields go up further then the returns will take a hit until liquidity turns better,” he said.
Deep N Mukherjee, director, Fitch Ratings, said previously, even though these risks existed they did not affect the volatility of the NAVs of the debt funds on a day-to-day basis. “Now they would be more volatile, with chances of generating negative returns if the interest rate movement in the broader market affects it negatively.”
So what is the way out for fund houses? Invest in securities with maturity less than 91 days to avoid marking to market. And even if yields shoot up, there is no impact on the price of the security and therefore, no situation of a negative return.
“Funds will have to bring down the average maturity in liquid plus lower, which could also mean more churning of assets,” said a fund manager.
Asked what about investors, another fund manager says, “If you don’t want volatility then buy funds that invest in papers maturing in less than 80 days or 90 days.”
Lower maturity would mean lower returns. But this is something investors will have to go with if they don’t want to lose money on their investment.