The paper also flagged off risks arising out of the concentration of HNIs and corporate institutional investors in the debt MF market, which makes fund schemes more susceptible to simultaneous and correlated withdrawals.
Stating that the relatively illiquid market for corporate debt in India poses a liquidity risk to debt mutual funds’ (MF) portfolios, a Reserve Bank of India (RBI) article has made a case for stipulating the ratio of government securities they hold in their portfolios. The paper also flagged off risks arising out of the concentration of high net worth individuals (HNIs) and corporate institutional investors in the debt MF market, which makes fund schemes more susceptible to simultaneous and correlated withdrawals.
“Given the dichotomy between economies of scale of a fund with large assets under management (AUM) and its adverse spillovers leading to macro-prudential concerns during stressed times, there’s need for a holistic approach, balancing the size and vulnerability, specifically with regard to open-ended debt funds,” the paper, published as part of the central bank’s June bulletin, said, adding, “One particular way to address the same may be through stipulating that the ratio of government securities in incremental holding should increase as the size of a debt scheme increases.”
Corporates and HNIs comprise more than 90% of the aggregate AUM of debt funds; in contrast, their share in equity funds is 48%. The extant regulations specify single investor concentration norms to diversify the investor base. However, when the investor profile is as dominated by risk averse investors as is the case in debt MFs, there still is a strong possibility of a few corporates distributing their surplus over four or five fund houses, and hence stress time exits could still be concerted, the paper said.
“Recent portfolio performance plays a disproportionate role in incremental inflows, typically masking illiquidity premium as (short-run) excess returns,” the article said. Iliquidity in the portfolio is not internalised by the asset management companies (AMCs) owing to the pass-through nature of the funds, while the excess returns arising out of such illiquidity have significant near-term upsides for portfolio managers in terms of excess corporate flows.
As a result, debt MFs show significant pro-cyclical behaviour by loading of spread risk when interest rate views are not benign and the resultant illiquidity of the portfolios is sought to be partially resolved through bank credit lines. “Such arrangements have inbuilt spillover of liquidity risk from the corporate bond market to inter-bank funding market,” the RBI article said.
The article follows the shuttering of six debt and credit risk funds by Franklin Templeton MF in April. It goes on to state that two peculiar design features of the Indian MF industry pose significant risks. One is the predominant profile of investors and the other is large correlated withdrawals specifically during stressed times, when credible counterparties are absent to provide liquidity.