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Earlier this week, capital markets regulator Securities and Exchange Board of India (Sebi) allowed certain categories of debt funds to invest up to 15% more of their assets in government debt, which is the most liquid form of debt in the Indian debt market. The move will help mutual funds build up liquidity to face huge redemptions. The facility has been provided to credit risk, corporate debt and banking and PSU debt funds for up to three months from the date of the circular (18 May).
Why was this necessary?
Open-ended funds allow investors to enter and exit at any time, although many have exit loads. Redemptions in debt funds increased in April after the covid-19 lockdown was announced and then shot up dramatically post the winding up of six Franklin Templeton Mutual Fund schemes on 23 April. Debt funds (excluding liquid and overnight) saw an outflow of around ₹9,000 crore in just three working days following the Franklin announcement, according to data from the Association of Mutual Funds in India (Amfi).
Category selection
One of the categories chosen, credit risk funds, saw large outflows. The other two, corporate debt and banking and PSU debt funds, have been chosen as a measure of precaution.
Credit risk funds have seen maximum redemptions as a proportion of their assets. Their size fell from around ₹48,000 crore on 24 April 2020 to around ₹35,000 crore by 15 May. These funds are required to invest at least 65% of their assets in papers rated below AA+ that tend to be highly illiquid. A reduction in such papers to 50% and a proportionate increase in government debt will help funds meet redemptions without resorting to extreme measures.
However, according to Feroze Azeez, deputy CEO at Anand Rathi Private Wealth, there could be redemptions in these funds going forward. Investors who have seen job losses, pay cuts or reductions in sales (if they are self-employed) may need to draw down their savings in such funds. Also, even AAA or AA+ corporate bonds can get suddenly downgraded, sparking a liquidity crisis. So this relaxation is largely a precaution.
Does this work for you?
“This precautionary measure by Sebi is good for all three debt categories," said Azeez. Your debt funds can take advantage of this relaxation to become more liquid. This is a big positive for you in times like these when the ability to withdraw your own funds is of utmost importance.
But will your returns get affected? The effect on returns is mixed because, on the one hand, government debt has lower yield and, on the other, debt fund managers will get more flexibility on when to deploy the money in corporate debt. According to Azeez, the possible negative impact on the returns of treasury bills (a form of government debt) compared to corporate bonds on an annual basis is just around 0.17%. He suggested that AMCs should still reduce their expense ratios to compensate investors for this amount.
This greater flexibility can allow them to generate high returns
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