MF redemptions

Mutual funds prepare for the shock of institutional flows

The month of September alone saw MF redemptions to the tune of Rs.3.14 trillion. That the redemption was carried out without too much of hiccups was a matter of satisfaction. But that raises a very serious question. Is the Indian mutual fund industry really ready for such a massive outflow of capital? This redemption was predominantly in liquid funds and to a lesser extent in income funds. But considering the size of our money markets and bond markets, any large selling can have a major impact on the bond market liquidity. What are the major concerns here?

Taxes and IL&FS

The withdrawal pressure came from liquid funds where mostly it is the corporates and institutions that invest. Such monies are temporarily parked in these liquid fund and income funds till the time the advance taxes have to be paid. That is a normal practice and funds provide for such withdrawals. What most funds did not really anticipate was that the IL&FS fiasco and the tightness of bond liquidity in the secondary markets, made distress sale necessary in many cases. For example, the DSP MF had to sell DHFL bonds at a yield of 11%, almost 3% higher than the market rate leading to a spiral effect on the equity markets too. IL&FS became the real issue and that is what led to this redemption as the internal guidelines of most treasuries did not permit holding on after the downgrade.

Regulatory clarity needed

There are a few areas where a little more regulatory clarity will be required. For example, when a crisis like the IL&FS default breaks out, should the rating agencies be permitted to downgrade the bonds by several notches in a single shot or should there be an advance warning system. Most mutual funds holding hundreds of crores worth of IL&FS bonds were caught off guard when IL&FS was downgraded by several notches. This was eerily similar to what happened in the case of Amtek Auto. Regulatory clarity is needed here. Secondly, what should be the write-off policy? When you don’t write-off the potential loss on the portfolio right away, you are helping exiting unit holders at the cost of existing unit-holders as they end up with the burden. BOI AXA took a call to write off 100% of its exposure to IL&FS. Regulatory clarity is required on this front too.

Good news on equity funds

In the midst of all the chaos, there was good news on equity fund flows. The number of folios added in the first 6 months stood at 65 lakhs over and above 2 crore folios added in the last 2 years. SIP inflows continue at over $1 billion per month. It looks like the equity fund investors have finally realized the merits of sticking to an equity story for the long term. One only hopes that their hopes in equity are not belied!