Exit loads in liquid funds would soon be a reality. Securities and Markets Board of India (SEBI) has mandated fund houses to charge a graded exit load in liquid funds for investments which are redeemed before seven days. This will be effective from October 20, 2019. Further, liquid funds will hold at least 20% of net assets in liquid assets (Cash, Government Securities, T-bills and Repo on government Securities) from April 1, 2020. To understand how the new norms in liquid funds will impact the returns and the yields, here is what leading fixed income managers have to say about the new regime.
Anju Chhajer, Senior Fund Manager, Reliance Nippon Life Asset Management Ltd.
Institutions will shift to overnight funds
Liquid fund assets under management could drop by 15-25% once the exit load is introduced. Institutional investors who deploy their overnight liquidity in liquid funds will shift their investments to overnight funds or will invest directly in Triparty Repo (TREPS). This will also reduce the volatility of AUM of liquid fund as stable money only gets invested due to imposition of exit load.
Gross yields could drop by 5-10 basis point
The returns of liquid fund depend on steepness of 1 day to 3-month curve. The new investment norms will not have any major change in returns of the fund. The norm of 20% investment in Cash T-bill and government securities may reduce the liquid fund gross yields by 5-10bps depending on the markets.
Leeway for fund managers
The new investment norms do not in any way impact the volatility of returns in the fund. The volatility of returns of the fund is dependent on the maturity of the portfolio. The reduction of volatility of the AUM due to imposition of exit load gives the fund manager leeway to take a broader call on rates without worrying about the daily redemptions in the fund due to volatility of daily returns.
Anurag Mittal, Associate Director & Fund Manager - Debt, IDFC AMC
Impact on inflows
Typically, institutional investors fall into 2 categories:
Financial Institutions: Banks/insurance companies who have direct access to overnight instruments like CROMS/CBLO but prefer liquid funds for higher returns and flexibility of daily inflow/outflow. With the exit load coming up there is a possibility that they directly deploy their excess liquidity in the overnight instruments. The estimated industry size of this segment would be Rs 70,000 crore – Rs 80,000 crore approximately.
Corporates: Corporates invest in liquid funds as they do not have access to overnight instruments and are constrained by a minimum lock in of one week in fixed deposits. While the exit load has still not been decided at the industry level, but assuming it’s a deterrent, prima facie there is a possibility that they might shift a reasonable proportion of their corpus to overnight funds and will only keep the money in liquid funds or bulk deposits where there is a visibility of seven days or more.
Impact on Returns
Due to the requirement of keeping minimum 20% in liquid assets (cash, Government Securities, Treasury & Repo on Government Securities) funds which are maintaining lower liquid assets could see their returns getting impacted. Most large liquid funds with AUM of Rs 10,000 crore above do maintain 10-15% in liquid assets.
Safety
The new investment norms will greatly help in improving liquidity profile in the liquid/overnight category and help in making the industry less susceptible to systemic/market risk.
Avnish Jain, Head of Fixed Income, Canara Robeco Asset Management Company
Better visibility for fund managers
Liquid funds allow investors to tailor their holding period to their needs. However, due to their nature, liquid funds used to witness lumpy flows from investors who used them as an instrument to park their daily surplus money and withdraw the very next day. In some cases, institutional investors would invest and redeem on a daily basis. This created a liquidity mismatch in the fund as investments in the fund are for longer tenure and the fund manager would have to manage the daily inflow/outflow via buying/selling of assets, which could have some impact cost on the fund. An exit load to the fund would lead the investors, who were interested to park investible surplus for a period of lesser than 7 days, explore other investment avenues like Overnight Funds, wherein 100% investments are restricted, by regulation, for one day and hence there is no mismatch. This change is expected to allow better visibility to fund managers to manage liquid funds in a more efficient way and reduce the overall risk.
Concentration risk is reduced
The need to keep 20% in cash or cash equivalents will reduce the overall yield from the fund portfolio while revised valuation norms will usher in an element of volatility in returns. Also, further tightening of sector caps for liquid funds—exposure to single sector will be limited to 20% as against 25% earlier—will reduce the concentration risk in these funds. However, investors in this fund would be getting well diversified portfolios and the NAV of liquid funds will now reflect the actual worth of the portfolio on any given day.
Dwijendra Srivastava, CIO-Fixed Income, Sundaram Mutual Fund
Ideal investment horizon
Assuming that the exit load kicks in, any new investor has minimum seven days holding period which evens out the volatility over the seven day holding period. Excluding the extreme volatility period and considering that liquid funds run a duration of around 30 days barring the quarter ends where the duration reaches 40 to 50 days, investor is fine with a 14-day holding period.
Portfolio yields could go down
Two important norms which can impact the investment returns in liquid funds are viz. the minimum holding of cash and T-bills to the tune of 20% and 100% mark to market. Both these norms should push down the average duration of the liquid fund which could reduce the overall portfolio yield as well. Having said this, it is also dependent on the portfolio manager’s style and reading of the money market rates and can vary across fund houses. In general, in the last quarter cash holdings and T-bills has been ~ 10% which increases to 20% will bring the portfolio yield lower by similar to 5 basis points.
Credit risk still remains
The new investment norms, if interpreted in true spirit, will lower the volatility but will not make an investor immune to the downside risk. Credit risk still remains. Duration risk may be lower but will depend on individual portfolio manager as a seven day exit load could prompt the manager to take a longer duration. In the end, if investors investment horizon is shorter than the optimal holding period, the investor is still exposed to a residual risk of downside although lower than before.
