Liquid funds may have to invest a fixed portion of their assets in government securities with the market regulator trying to make them safer and more liquid—a development that fund managers fear will impact returns and reduce flexibility.
A committee of the Securities and Exchange Board of India (Sebi) is considering the proposal, which is still being fine-tuned, two people aware of the development said, requesting anonymity.
“A sub-committee under the mutual fund advisory committee (MFAC) is currently working on devising the norms for a liquidity buffer for all liquid funds. It could be as high as 19% of the assets," said the first person cited above.
If approved, this would be akin to the statutory liquidity ratio (SLR) requirement on banks, where lenders have to keep a certain portion of their money in government bonds.
According to the second person cited above, the proposal aims to insulate liquid fund investors from losses in case of negative credit events. “One of the ways to do this is to ensure a high liquidity buffer for funds with higher assets under management (AUM) as compared to liquid funds that have lower assets. This has not been finalized yet," the person added. The report will be submitted later this month to MFAC, which will make its recommendations to Sebi, he added.
Fund managers are, however, not pleased.
“A T-bill (treasury bill) is settled on a T+1 basis, while a certificate of deposit or commercial paper is settled on a T+0 basis. The Sebi proposals, while increasing overall liquidity, can pose a new set of liquidity challenges," said R. Sivakumar, head (fixed income), Axis Asset Management Co. Several liquid funds allow same-day redemption to retail investors of up to ₹50,000 or 90% of the value of the investment, whichever is lower.
Industry professionals also noted the potential impact on returns.
“This will be a retrograde step and will make liquid funds less attractive as returns will come off. Mutual fund penetration is still low and they need to be encouraged as savings products," said Ashish Shanker, head, investment advisory, Motilal Oswal Private Wealth Management.
According to data from Value Research, liquid funds as a category currently hold 14.08% of their assets in government securities. This is not greatly different from the 19% being considered by Sebi. “However, this is the case at present. Tomorrow, a fund may wish to have 10% in government securities or 20%. It should be given this flexibility," said a fund manager, requesting anonymity.
“As an alternative idea to prescribing SLR type requirements, one may consider allowing different schemes for institutions and retail investors.
A threshold of ₹1 crore can be imposed per PAN/Aadhaar on non-institutional liquid funds," said Mahendra Kumar Jajoo, head, fixed income at Mirae Asset Global Investments (India) Pvt. Ltd.
But, a section of fund managers welcomed the proposal.
“It will enhance liquidity and there can be a small impact on returns of 7-8 basis points for liquid funds," said Avnish Jain, head (fixed income), at Canara Robeco Asset Management Co. A basis point is one-hundredth of a percentage point.
Liquid funds have delivered a one-year return of 6.94% on an average. Their three- and five-year average returns stand at 6.79% and 7.42% CAGR, respectively. The debt crisis emanating from groups like IL&FS did not impact liquid funds to the same extent as credit risk funds.
Among the 44 liquid schemes in India, only a handful had exposure to troubled groups.
Only Principal Cash Management Fund and Union Liquid Fund have one-year returns of less than 5%, standing at -1.92% and 3.62%, respectively (for regular plans).