Hitch in money market funds

Hitch in money market funds
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First Published: Thu, Oct 16 2008. 12 36 AM IST
Updated: Thu, Oct 16 2008. 12 36 AM IST
A close look at the portfolios of the various money market mutual funds that are now facing redemption pressure reveals one interesting fact and one worrisome one.
The interesting fact is that most of the money these short-term funds have raised from investors has been lent to financial companies and banks. It is also now known that companies are large investors in these funds. This means that the Indian money market is currently a perverse mirror image of what it should be. In most well-functioning money markets, it is banks and financial companies that lend to companies for their working capital needs. In India right now, we see the opposite: companies lending short-term money to banks.
Now, let’s get on to the worrisome fact. Some funds have lent at least one-third of their funds to finance companies, both purely domestic ones as well as local subsidiaries of foreign banks. Some of this is direct lending through certificates of deposit and commercial paper, while some of it is indirect lending through structured finance products such as securitized receivables and pass-through certificates.
That is cause for worry. These finance companies are aggressive lenders to realtors, small businesses and what can be called subprime consumers—high-risk and high-return customers. The risk is perhaps the more valid parameter to look for right now. There are reports of realtors in trouble and mounting delinquencies in consumer loans. This could put some finance companies in trouble and perhaps curb their ability to meet their payment obligations to short-term money market funds.
All this shows that the fears of investors who are rushing to pull money out of these funds are not completely irrational. We doubt there will be large-scale implosions in Indian money market mutual funds. But it is also worth noting that their portfolios are not made up of safe government securities; relatively more risky paper dominates.
Mutual fund companies have aggressively sold products such as fixed maturity plans to investors, positioning them as safe alternatives to low-yield bank deposits. The chickens have now come home to roost.
Have money market mutual funds taken too many risks? Write to us at views@livemint.com
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First Published: Thu, Oct 16 2008. 12 36 AM IST
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