Mumbai: Rating agency Crisil Ltd on Tuesday advised the mutual fund (MF) industry to valuate its investments in state government loans (SDLs) differently from how banks do.
SDLs are bonds floated by state governments and are auctioned by the Reserve Bank of India.
According to standard practice, banks value SDL bonds at 0.25% above similar maturity government paper issued by the Union government. But the same approach is not right for MFs, Crisil said, because they have to value their portfolio on a daily basis and provide nominal losses if required.
If the MF industry uses the banks’ way of valuing the bonds, “it would mean valuing SDLs at lower than prevailing market yields or at higher than prevailing market price. If these are then sold in the market, since it has to be at the prevailing market price, it can result in losses,” Crisil said.
The agency has suggested that mutual funds adopt a robust valuation approach for SDLs and factor in, among others, “market traded levels, frequency of trades, and the state concerned, to make it aligned to ground realities.”
“A simulation exercise on market traded yields of SDLs reveals that valuations, if done improperly, could potentially lead to a loss of even 7-8% on a single security within a day of purchase,” said Krishnan Sitaraman, director of Crisil Fund Services.