The Securities and Exchange Board of India (Sebi) has accepted graded exit load recommendations prepared by the Association of Mutual Funds in India (Amfi) for redemptions in liquid funds within seven days of investment. The regulator had previously tasked Amfi for formulating the exit load in its 20 September circular. The move is aimed at deterring corporates from using liquid funds to park their money for very short periods. Big purchases and redemptions from corporates can amplify the risk in these funds for retail investors, especially in times of poor liquidity or credit concerns in the debt market.
Redemption after the first day of investment will cost 0.0070% in exit load; after the second day, it will be 0.0065%; after the third day, 0.0060%; after the fourth day, 0.0055%; after the fifth day, 0.0050%; and after the sixth day, 0.0045%. The exit load will be nil from the seventh day. In other words, on a redemption of ₹1 crore, the exit load would be ₹700 after the first day, ₹650 after the second day and so on. However, Amfi is required to review the exit load structure on an annual basis.
The percentages look small in absolute terms but are significant when compared with the returns of liquid funds in very short periods of time. For example, a ₹1 crore investment at 6% will earn a pre-tax return of around ₹6 lakh. This works out to about ₹1,643 over one day. An exit load of ₹700 would eat into almost half this return, making it unviable for a company to redeem in a day.
“The move is positive for all types of investors, retail and institutional as well as AMCs," said Mahendra Kumar Jajoo, head, fixed income, Mirae Asset Mutual Fund. “It will reduce the risk from large short-term inflows and redemptions in liquid funds. However, it may call for a realignment on part of institutional investors as to their investment choice," he added.
Overnight funds are the most immediate substitute for institutions. Large institutional investors can instead move their money to overnight funds where there will be no graded exit load. Overnight funds were a category Sebi created in October 2017. They can invest in securities that have a maturity of one day. As of September 2019, liquid funds had assets under management of ₹3.88 trillion compared to just ₹13,851 crore in overnight funds, indicating that a shift from them to overnight funds has not yet happened in a big way.
Fund managers dismissed the notion that corporates might move to bank fixed deposits (FDs). “Banks do not offer any interest for deposits of less than seven days while mutual funds will give some returns even after the exit load," said Dwijendra Srivastava, chief investment officer (debt), Sundaram Mutual Fund.
A seven-day bank FD in State Bank of India (SBI) earns just 4.5% (annualized). However, the average liquid fund return is 6.88%. Bank FDs also have TDS (tax deducted at source) on accrued interest, while resident investors don’t need to pay TDS on capital gains in mutual funds. However, they have to pay self-assessment tax on these gains.
What it means for you
The move is a positive for retail investors as it lowers the chances of volatility caused by big flows in liquid fund returns. However, they will also be subject to the seven-day exit load.
Retail investors can shift to overnight funds for very short time frames or ultra short duration funds if they can invest for three to six months. Ultra short duration funds are also subject to fewer restrictions than liquid funds such as the need to hold 20% of assets in cash and cash equivalents like treasury bills and repo on government securities. Ultra short duration funds have given an average return of 7.15% compared to 6.88% for liquid funds over the past year.
“Retail investors should choose a bucket that’s aligned with their time horizon. If they’re investing for less than seven days, they should pick overnight funds. If they’re investing for one to three months, they should pick liquid funds, and so on," said Deepali Sen, founder partner, Srujan Financial Advisors.
The graded exit load will also affect liquid funds which were offering “insta-redemption". Axis Liquid Fund, HDFC Liquid Fund, IDFC Liquid Fund, Nippon India Liquid Fund, DSP Liquidity Fund, ICICI Prudential Liquid Fund and Kotak Liquid Fund, among others, offer redemption—up to ₹50,000 or 90% of the amount in the fund, whichever is lower—within 30 minutes of giving the request. However, Pravin Jadhav, managing director and CEO, Paytm Money, an online direct mutual fund platform, said it won’t matter. “We see about 20% of all our investors using our feature where we allow insta redemption on liquid funds. The average holding time of our users is a little more than 45 days," he added.
Investors should wait for seven days before exiting liquid funds.