The capital market regulator, Securities and Exchange Board of India (Sebi), has mandated through a circular it issued on 26 November that liquid funds must issue units to investors only after the money reaches the fund’s bank account before the cut-off time. Sebi has pushed back the cut-off time for liquid funds till 2pm, up from the present 12 noon.
Earlier, sometimes liquid funds used to allot units for application received before the cut-off time (12 noon) even though the money reached the fund house later in the day. In the interim, mutual funds (MFs) used the intra-day credit facility with banks with whom they had an account and borrow the money to be invested. Such investors would then, typically, pay up by, say, evening, and still get units at the previous day’s net asset value (NAV).
“This was a risk to MFs. If, say, the investor defaulted, MFs had to make good the loss. Why should MFs bear this loss unnecessarily?” says a fund manager, who refused to be named.
No intra-day credit facility for liquid funds
Now, liquid funds will not be able to make use of any credit facility (to borrow money temporarily on the unitholder’s behalf) before issuing units against it. Investors would need to ensure that their own money reaches the MF’s bank account by the cut-off time (2pm). Ditto for income schemes, other than liquid schemes, though their cut-off time remains 3pm.
No extra day returns
Sebi’s move also puts a stop of a popular practice resorted by large and institutional investors to get an extra day’s return. Such investors used to enter a liquid fund and then immediately switch to an ultra short-term (ST) fund, both on the same day. Since units in a liquid fund are available at the previous day’s NAV, institutional investors typically invest in a liquid fund by the cut-off time, say on Monday. They would, therefore, get Sunday’s NAV (liquid funds declare NAVs on Sundays, too). On the same day itself—after the erstwhile cut-off time of a liquid fund—they would shift this money to an ultra ST fund or an income fund by the cut-off time (3pm; all schemes other than liquid funds have a cut-off time of 3pm). Thus, they get a day’s gain in the liquid fund, absolutely free (Sunday to Monday). Though the actual money would reach the income fund only on Tuesday morning (since money deployed by the liquid fund would need to remain invested for at least 24 hours), MFs used the intra-day bank credit facility to ensure that investors do not lose out on a day’s gain.
Not anymore. Since income fund units also need to be issued only after receiving investor’s own money—and not borrowed from banks—investors would need to transfer the money on the same day (Monday, in the above example) to be able to get a free day’s gain. But since the liquid fund money comes only after 24 hours— Tuesday, in our case—the investor will get Tuesday’s end of day NAV. The investor’s clock in the ultra ST fund thus starts to tick from end of Tuesday; he would not get the Monday-to-Tuesday gain.
Not all funds are pleased with this move. “Giving liquid fund units after the realization of money is fine. But at least Sebi should allow us to give units as per the previous day’s NAV in terms of a switch-in. When the investor switches from liquid fund to an ultra ST fund, the actual money comes next day morning itself. He unnecessarily loses out on a day’s gain,” adds another fund manager, who was not happy with Sebi’s decision. This fund manager also added that availing of intra-day bank credits is not bad; at worst MFs should be allowed to use such a facility on days when the money transfer systems of banks fail for a few hours here and there.
Interval funds’ loophole plugged
In yet another loophole that Sebi has plugged, interval funds would need to invest in scrips that mature along with the fund’s maturity. These are closed-end funds (allowing premature redemptions through daily or monthly redemption windows) that are open for fresh subscriptions every few months. They are like fixed maturity plans (FMPs) that are meant to invest in scrips that mature before the schemes themselves mature.
However, unlike FMPs that come with a specified term, interval funds are in perpetual existence, except that they have fixed windows—or intervals, where investors can enter afresh for a fixed time, before the next subscription window reopens.
However, a lot of interval funds used to invest in scrips whose duration was far higher than that of the scheme itself. For instance, a three-month interval fund (a perpetually-existent scheme which opens for fresh subscription every three months) used to invest in scrips that mature after a year. “This created a huge asset-liability mismatch. Incase of premature redemption, selling such scrips used to negatively impact investors who stayed on with the scheme,” said the fund manager. Sebi says that these schemes would now be mandated to be listed on the stock exchanges; premature redemption will be allowed through the stock exchange route.