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On 18 May, capital markets regulator Securities and Exchange Board of India (Sebi) allowed certain categories of debt mutual 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 regulator's move is aimed at allowing mutual funds to build up liquidity, given that the industry was under pressure recently following massive redemptions post the winding up of six Franklin Templeton Mutual Fund schemes on 23 April.

Sebi has provided this facility to corporate debt funds, credit risk funds and banking and PSU debt funds for a period up to three months from the date of the circular.

Why was this necessary?

Remember that open-ended mutual funds allow investors to enter and exit at any time, although many have exit loads for investors getting out in short spans of time. Redemptions in debt funds increased in April after the covid-19 lockdown was announced and then shot up dramatically after the winding up of six Franklin funds. 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). Government securities are highly liquid and can be sold easily in the market to meet redemption pressure.

Why were three categories selected?

Credit risk funds have seen maximum redemptions as a proportion of their assets. Their size fell from around 80,000 crore in April 2019 to around 31,000 crore by 15 May.

These funds are required to invest at least 65% of their assets in papers rated below AA+ and such papers tend to be highly illiquid. A reduction in such papers to 50% and a proportionate increase in liquid government securities will help funds meet redemptions without having to resort to extreme measures.

Corporate bond funds have to invest at least 80% of their assets in AA+ and above bonds which tend to be more liquid. Banking and PSU funds have to invest at least 80% of their assets in debt issued by banks and public sector enterprises. Sebi has allowed them to reduce these limits to 65% each.

On the face of it, this seems unnecessary. Corporate bond funds and banking and PSU debt funds did not witness significant redemption pressures. However, according to Feroze Azeez, deputy CEO at Anand Rathi Private Wealth, there could be redemptions in these funds going forward simply to meet the cash flow needs of investors. In other words, 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.

Will this last forever?

No, this relaxation is only for three months from the date of the circular (18 May). In addition, asset management companies (AMCs) need to seek approval from their AMC boards, Trustee boards and internal investment committees. They also need to maintain a written record of the reasons for availing of this relaxation.

Will this affect your returns?

Not much. According to Azeez, the impact of investing in 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.

Rajeev Radhakrishnan, head, fixed income, SBI Mutual Fund, pointed out another benefit. Banking and PSU debt and corporate bond funds can deploy money into corporate bonds without the compulsion of immediate deployment. This greater flexibility can allow them to generate higher returns.

Your debt funds can take advantage of this relaxation to become more liquid. This can help a great deal in volatile markets to soothe investor anxiety.

This is a positive for you as you will be able to withdraw from your funds whenever you need to. The effect on returns is mixed and can, in fact, be positive due to the additional flexibility.

ABOUT THE AUTHOR

Neil Borate

Neil heads the personal finance team at Mint. A former colleague called them 'money nerds' and that's what they are. They cover topics like mutual funds, taxation and retirement, all to improve your chances of building wealth. Neil graduated with a degree in law and economics. He passed the CFA Level I exam and began his writing career at Value Research, a mutual fund research firm in 2016. He joined the personal finance team Mint in 2019. Everyday, the Mint Money Team tackles personal finance questions such as where to invest and where to borrow, through articles, charts and reader queries. They also have a daily podcast - 'Why Not Mint Money' and an annual ranking of mutual funds - the Mint 20.
Catch all the Business News, Market News, Breaking News Events and Latest News Updates on Live Mint. Download The Mint News App to get Daily Market Updates.
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