Column : Breather for mutual funds

Written by Muthukumar K | Muthukumar K | Updated: Jun 29 2010, 04:25am hrs
Sebis move to stretch the deadline to comply with new debt norms for mutual funds has come as a breather for the industry. Debt funds this month have been facing huge redemptionsexpected to touch levels of Rs 1,00,000 crore. The memories of 2008, when some mutual funds faced huge liquidity problems, are yet to fade away and the last thing that the regulator wants is a repetition. While this extension is a commendable step by the regulator, there are challenges to be faced. For instance, what happens to existing investorswill they lose out since the new norms specify marking-to-market all debt papers with remaining maturity of more than 91 days Earlier, the period was 182 days. This will affect the NAVs of liquid/short-term funds, whose average holding period of debt papers is higher.

If interest rates rise during this period, existing investors would take a hit. Debt papers, particularly those between 91-182 days, would be marked to market. This would cause bond prices to fall. But if investors could exit one day before the deadline, they could do so at a higher NAV. In such a case, it is the remaining investors who bear the brunt whenever the NAV corrects. On the flip side, if interest rates fall during the period, investors could hold on till the deadline, let the fund NAV appreciate and then exit. Many years ago, there was a system where the investors of a particular mutual fund house allotted the NAV to its investors one day before the buying date. If the market rose during that day, some smart investors bought into it. However, such arbitrage opportunities were stopped when the fund house changed the rules.

All said, Sebis move to reduce the period for mark-to-market from 192 to 91 days has its merits. It serves to check the higher portfolio risk that some short-term-oriented debt funds are not supposed to take. In its quest for higher returns, it was seen that liquid and short-term funds were investing in long-term papers. This was against the investment mandate. But since investors chase returns, some fund managers stretched the limits. The new norms will check these risky investment practices.