Money market funds face intense redemption heat

Liquidity crunch sees banks, companies withdraw Rs30,000 cr from such funds over the past fortnight

The liquidity crunch in the Indian financial system has taken a toll on the mutual fund industry. Liquid and liquid-plus funds, popular debt schemes among corporate investors and bank treasuries for parking surplus money, are seeing heavy redemption. An estimated Rs30,000 crore, or about 30% of the corpus of such funds, has been withdrawn in the past fortnight, according to two fund managers and the head of treasury operations of a diversified group.

According to the Association of Mutual Funds in India, an industry lobby, liquid and liquid-plus funds, also known as money market funds, constituted a quarter of the Rs3.6 trillion of assets under management in debt, or fixed income, funds at the end of August, the last month for which such data is available.

India’s total assets under management in the mutual fund industry were Rs5.4 trillion in August. This came down to Rs5.2 trillion in September.

“There a liquidity problem but we don’t see any credit crunch,” said Ritesh Jain, head of fixed income at Principal PNB Asset Management Co. Pvt. Ltd, which manages about Rs10,000 crore worth of assets.

Liquid-plus funds had a particularly tough time in the previous week with 33 of 291 of such funds declining in value between Wednesday and Friday. Fund managers had to sell some assets below cost price due to heavy redemption by banks and firms, said industry analysts, dubbing this a rare occurrence for such schemes.

Market watchPeople outside the BSE building. Investors fear liquid and liquid-plus funds could be sitting on huge losses. PTI

One such fund house—Mirae Asset Global Investment Management (India) Pvt. Ltd— has eight variants of its liquid-plus schemes quoting at a discount to par value, or the price at which an investor bought units of the scheme.

“The very essence of money market funds is that they don’t dip below par,” said Dhirendra Kumar, chief executive of Value Research India Pvt. Ltd, a mutual funds research firm.
While liquid funds can mark to market up to 10% of their assets, liquid-plus funds can have more assets marked to market, an accounting practice of assigning a value to a position held in a financial instrument based on the current market price for that instrument.

In liquid funds, the drop in net asset value (NAV) is not as stark as in the liquid-plus funds because of the 10% cap on the accounting practice of marking to market its assets under management.

“Though there is no regulatory diktat on it, most liquid-plus funds also keep only a small portion of their portfolio in instruments that are marked to market,” said a fund manager who didn’t wish to be named.

The fear, thus, is that many of these liquid and liquid-plus funds could be sitting on huge losses in the rest of their portfolio, which is held to maturity.
If the liquidity crunch continues for long, the funds may have to recognize the losses and pass them on to the investor. Else, the funds themselves will have to make good the losses by injecting cash in the scheme.

Most fund houses have a small capital base, sometimes as low as Rs10 crore, which would prove insufficient as losses could be more. In the current scenario, when short-term rates have risen by 400 basis points in three months, a six-month maturity portfolio would be out of money by 2%. One basis point is one-hundredth of a percentage point.

“Getting a bank line (of credit) is not easy,” said Ganti Murthy, debt fund manager at SBI Funds Management Pvt. Ltd. “Banks are facing liquidity tightness themselves.”
Markets regulator Securities and Exchange Board of India, or Sebi, does not call for capital protection in the liquid-plus schemes currently available. But, according to analysts, it has been taken for granted that fund managers handling such schemes would invest in a combination of papers to ensure NAVs are maintained above par value in normal times.

But these are unusual times, and redemption by firms and banks have risen sharply, said many fund managers.

“Nobody has money to buy these assets,” said Ashish Nigam, head of fixed income at Religare Aegon Asset Management Co. Pvt. Ltd, which is yet to launch any scheme.
As overnight lending rates rose, banks redeemed their liquid-plus schemes to be able to lend to other banks at higher rates in the inter-bank money market.

Interest rates on the overnight inter-bank call money market crossed 20% on Friday, the highest since April 2007, as banks rushed to borrow from each other to tide over their temporary asset-liability mismatches. Since then it has come down after the cash reserve ratio (CRR, or the balance banks need to maintain with the central bank) cut.

Companies, on the other hand, have been getting higher returns from fixed deposits with interest rates on such deposits for one month rising to 12%, from 8-9% a month ago, said N.S. Paramasivam, head of treasury at Essar Group, a steel-to-oil conglomerate. “This has made many corporates switch over from mutual funds to FDs (fixed deposits).”

In a tight credit situation, yields, or interest rates, on debt instruments rise and their prices fall, hurting NAVs of money market funds.

While liquid funds typically invest a majority of their assets in debt instruments that are of one- seven-day maturity, liquid-plus funds hold a large chunk of their assets in papers with one- three-month maturity. Liquid-plus funds are becoming increasingly popular as they are more tax efficient for investors.

To be sure, funds are now rebalancing their portfolios and switching to papers with a shorter tenure. “This will ensure the funds’ liabilities (the money they manage) which can be redeemed every day will be in line with the tenure of the paper they invest in, said Paramasivam.
According to Jain of Principal PNB Asset Management, the liquidity problem could be solved “as early as in a fortnight or so”.

The Reserve Bank of India’s move in cutting banks’ CRR infused Rs60,000 crore in the financial system last Saturday. “This and more such measures are expected to help the industry tide over the crisis of confidence,” said Paramasivam.

Source: http://www.livemint.com/2008/10/14001655/Money-market-funds-face-intens.html?pg=1