SEBI’s quest to secure debt funds would make liquid schemes less lucrative, feel experts

After a series of bond failures, starting with the IL&FS crisis, hit the trusted debt fund segment hard, leaving the investors jolted and shaken, market regulator SEBI has announced new guidelines to make the segment more secure and restore investors’ confidence.

“The SEBI placed a series of guidelines to tighten certain investment and valuation norms for debt mutual funds in the wake of defaults and downgrade of credit papers for some troubled entities which subsequently led to erosion in value of investment within a short span of time. The tight credit squeezes during the aftermath of the NBFC/HCF crisis further led to liquidity crunch in the system which had ripple effect on sectors as well as on the sentiment of investors. The new guidelines on debt funds from SEBI is likely to protect the interest of investors at large and also act as catalyst to win back the lost confidence among investors especially for liquid funds,” said Dinesh Rohira, Founder & CEO, 5nance.com.

To instill the confidence back, SEBI has taken several stringent measures.

“Owing to the recent credit crisis, SEBI has rightfully tightened guidelines for debt mutual funds. Stringent guidelines are aimed at not only protecting investors interests but also further improve transparency by improving disclosure requirements. As per the new guidelines, SEBI has mandated liquid mutual funds to hold at least 20 per cent in liquid assets such as cash, government securities and treasury bills. Introduction of exit load on liquid scheme investors up to 7 days may lead to lumpy flows to other debt categories such overnight and money market,” said Devang Kakkad, Head of Research with Equirus Wealth Management.

“Additionally, SEBI has reduced sector exposure from earlier 25 to 20 per cent and similarly additional exposure of housing finance companies (HFC’s) has been reduced from earlier 15 per cent to 10 per cent. Taking a stringent view on mutual funds investing in securities backed by pledged shares (credit enhancement), SEBI has directed MF’s to ensure to have cover of 4 times instead of current practice of 1.5 – 2.0 times. SEBI’s measures are aimed at increasing investor confidence while improving overall disclosure norms by MF’s,” he added.

The new guidelines have been framed to make debt funds more transparent.

“The changes in sectoral exposure capped at 20 per cent from earlier 25 per cent in single sectors coupled with only 10 per cent allowed in housing finance companies is expected to bring down concentration risk and enhance diversification in overall portfolio. Further, with liquid funds mandated to hold at least 20 per cent assets in cash and equivalent, it is likely to reduce the liquidity risk in category while other measures like mark-to-market and appropriate security covers will bring level playing field with additional transparency and liquidity in overall debt funds category,” said Rohira.

However, the strict measures may make liquid funds less lucrative and volatile.

Following are some of the guidelines and their probable impact according to experts.

1. Exit load on liquid funds.

“Owing to the exit load, investors have apprehensions over investing and they prefer overnight funds. Liquid funds are designed for investing surplus money and withdrawing them when the need arises. Some investors park their money on Friday and take it out on the next business day on Monday. Exit load fees will influence investment decisions,” said Ankit Agarwal, Managing Director, Alankit Limited.

“This may hinder certain kinds of investors from investing in liquid funds,” said Dheeraj Singh, Head of Investments, Taurus Asset Management Co. Ltd.

2. Liquid funds to invest at least 20 per cent of their money in government securities, cash and equivalents.

“The new norm of minimum 20 per cent holding of cash/govt securities may result into moderate returns from liquid funds in the medium/long term,” said Singh.

Sighting the positive impact of this measure, Agarwal, however, said, “Liquid funds will get a boost when it comes to facing cash crunches in case of large redemptions.” Adding, “However, this would minimise returns on such funds.”

3. MFs can only invest in listed NCDs. Fresh investments in CPs and equities only allowed in listed ones.

“A rise in the liquidity of NCDs, CPs and equities is expected. Since listed NCDs are mandatorily rated by credit agencies, it will enhance transparency,” said Agarwal.

“Commercial papers by nature are unlisted instruments. We will have to await the issue of detailed guidelines by SEBI to understand what they actually mean by listed CPs,” said Singh.

4. All debt securities will now be marked-to-market.

“This is likely to make liquid funds more volatile. This gives the real picture as these funds would now be valued on the current market prices,” said Agarwal.

5. Caps of funds’ exposure to individual sectors, issuers, structured instruments, unlisted securities and loans against shares.

“A reduction in risk concentration on individual sectors is expected and this would spread it across various sectors thereby diversifying the portfolio. Those sectors which attract large investments are likely to lose liquidity, and increasing liquidity in other sectors,” said Agarwal.

6. Adequate security cover of at least 4 times for investment by MF schemes in debt securities with credit enhancements backed by equities directly or indirectly.

“While there will be a reduction in the risk, there will also be an increased burden on mutual fund houses,” said Agarwal.

7. Prudential limits on total investments in debt and money market instruments having credit enhancements as percentage of their respective debt portfolios is prescribed at 10 per cent.

“It would help provide security against debt downfalls since increasing the time limit will offer a better judgement of the company’s strength,” said Agarwal.