Recent revisions in Liquid Fund norms to minimize credit and liquidity risk

Recent defaults and credit rating downgrades have dented investor confidence.

So, to bring back confidence and ensure that investors’ long-term interests are protected, SEBI has tightened certain investment and valuation norms for debt funds, including liquid funds.

Before we look at these changes, which aim to protect investors from credit as well as liquidity risk, let’s set a little context…

Liquid funds seem to be high on the list of mutual fund investors’ favourites

They constituted as much as a fifth of the total open ended AUM as on 31st October, 2019. While the total AUM of all open-ended funds was Rs. 24.48 lacs crores, the AUM of liquid funds alone was Rs. 4.83 lac crores.

Since the size of the liquid funds category is so huge, market regulator SEBI constantly monitors this category and ensures that investors are adequately protected through the revision of existing rules, where necessary.

Earlier, liquid funds were classified as the least risk category among all categories of mutual funds. However, recently, SEBI has introduced a new category – namely Overnight Funds – which are one notch higher than liquid funds in terms of safety. Both these categories of funds are good alternatives to savings banks due to similar liquidity and low-risk nature.

Introduction of Exit Load on Liquid Funds

SEBI has now mandated the levy of an exit load on liquid fund redemptions. With effect from 20th October 2019, SEBI has introduced a graded exit load structure on liquid funds (applicable on fresh investment) on redemption within 7 days of investment. No exit load will be applicable on redemptions beyond 7 days. The structure of the load is as given below:

frequently as prices could swing in the event of increase/decrease of interest rates or changes in credit ratings.

These regulatory changes will make liquid schemes more transparent for investment. The measures are in the right direction to protect investor interest and also necessary at this point of time in order to win back the lost confidence of investors.

What course corrections do these changes call for in a mutual fund portfolio?

Going ahead, investors willing to park funds for up to a week should consider investment in overnight funds. This would be an ideal alternative to parking funds in a current account.

If the time horizon for investment is more than a week but up to 3 months then investors could consider liquid funds, specifically if their funds are lying in a current account; for funds lying in a savings account, one can take a call based on the quantum;investors would also need to take into consideration the fact that in case of savings account we are not sure of how the interest gets calculated as a layman. However, for mutual funds, the returns can be calculated easily as they are a point to point returns.

For investments between 3 months to 6 months, an ultra-short-term fund is a preferred category.

Investors having minimum investment tenure of more than 6 months can also opt for Arbitrage Funds. To know more about arbitrage funds refer to our previous month’s article “Arbitrage Funds: A Good Short Term Investment in Volatile Markets”

Average returns given by liquid funds during the past 6 months

As we can see from the chart above it is evident that the returns have reduced in the last 6 months. Due to the implementation of the above regulations, the returns may fall further in the future.

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Disclaimer:

We, Ventura Securities Ltd, (SEBI Registration Number INH000001634) its Analysts & Associates with regard to blog article hereby solemnly declare & disclose that:

We do not have any financial interest of any nature in the company. We do not individually or collectively hold 1% or more of the securities of the company. We do not have any other material conflict of interest in the company. We do not act as a market maker in securities of the company. We do not have any directorships or other material relationships with the company. We do not have any personal interests in the securities of the company. We do not have any past significant relationships with the company such as Investment Banking or other advisory assignments or intermediary relationships. We are not responsible for the risk associated with the investment/disinvestment decision made on the basis of this blog article.

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