Mutual Funds brace for outflow

Mutual funds may have to take a hit of around Rs 35,000-40,000 crore over the next six months.

The Reserve Bank has restricted banks from investing more than 10 per cent of their net worth as at the end of the previous financial year in the liquid/money market funds of mutual funds.

Banks that have investments over and above this cap are allowed to bring them down to the prescribed limit in the next six months.

At the end of March 2011, liquid/money market schemes of mutual funds had Rs 73,666 crore of assets under management.

Clearly, banks are going to pull their investments out of liquid funds over the next six months which could lead to an outflow of Rs 35,000-40,000 crore from liquid funds.

In my opinion banks have investments in almost all mutual funds and, therefore, most funds will suffer from this directive of the RBI. However, since banks comprise only a part of the institutional business of asset management companies, the effect of the outflow will be only partial and we would like to compensate this by getting in more corporate clients, NBFCs and insurance companies.

In the monetary policy announcement, the RBI governor said this measure was taken “to prevent systematic risk in times of liquidity crunch”.

Such a crisis had emerged in September-October 2008 after the sub-prime crisis came to light and Lehman Brothers fell in the US. There was a massive redemption pressure on mutual funds, and they had to stop payment to investors because of liquidity constraints. Banks were directed to extend additional liquidity support to mutual funds to help them handle the crisis.

Subsequently, market regulator Sebi revised the valuation norms for debt securities held by mutual funds, and from July 1, 2010 it had been mandatory for funds to mark to market (traded value) debt and money market securities with residual maturity of 91 days.

Following this, the debt schemes, particularly the short-term ones, became volatile in terms of NAV. This change in valuation norms also witnessed a large outflow of investment by institutional investors from liquid and ultra-liquid schemes. AUM of liquid funds, which stood at Rs 73,666 crore as at the end of March 2011, was Rs 78,094 crore at the end of March last year and Rs 90,594 at the end of March 2009.