Markets regulator Sebi has decided to put on hold clearances of new fund offers by closed-end debt funds, popularly known as fixed-maturity plans (FMPs). The market regulator is working with the mutual fund industry to come up with new guidelines for FMPs. The new regulations would include a lock-in period to correct any asset-liability mismatch. Sebi is also expected to direct funds to use the secondary market to raise resources for these funds by floating them on stock exchanges.
Under normal circumstances, FMPs compete with bank fixed deposits to provide higher returns and a better tax deal. While on FDs, investors had to pay tax at the applicable marginal rate, but it?s a flat 10% on FMPs for investments over a year. These plans basically invest in debt paper expected to mature after a year.
Problems arise as investors usually make periodic redemptions way before maturity. Usually, a new fund?s inflows balance out redemptions. But the market meltdown from September has made inflows scarce but redemptions have spiked. High net-worth individuals and corporate treasuries have exited debt-related funds. MF houses have borrowed heavily from the markets and even sold investments to meet redemptions, leaving the net asset value of FMPs in tatters.
The Sebi move will rectify these problems by locking in investments and permitting them to use the secondary markets to raise funds, instead of having to sell investments made from the funds. ?I believe Sebi is working on a set of guidelines for FMPs,? Uday Kotak, managing director, Kotak Mahindra Bank, told FE on Tuesday.
AP Kurian, chairman, Association of Mutual Funds in India (Amfi), told FE his body was working closely with Sebi ?with a view to build in more transparency and investor friendliness for FMPs?. In October, Amfi figures show that income-and debt-related funds saw Rs 52,820 crore in redemptions. Compare this with the Rs 706 crore outflow from equity funds. Little wonder funds net sold debt instruments worth Rs 24,837 crore in October.
The Sebi proposal will also cap the maximum exposure of an FMP to a sector and a company. FMPs as debt instruments are not expected to invest more than 15% in a single offering of a company, which could be extended to 20% with the trustee?s permission. But since these plans have a short life?one to four years?fund houses were not required to disclose their portfolio on a regular basis as for other schemes. Hence, several funds had exposure to only one sector or even a single company.
An industry expert said there are cases where funds could receive exemptions on the limit as was the case with some money market-related products like certificates of deposit or certificates of participation. ?They did not violate any norms. But, yes, this can be termed unprofessional, extremely risky and against the spirit of diversification, for which mutual funds are created in the first place,? says a leading fund manager with a domestic fund.
?In many cases, the fund would have started off with a proper fund allocation, and then due to redemption and asset liability mismatches, end up having a skewed allocation,? the fund manager added.