Last week, SEBI rolled out yet another set of new rules governing the operation of mutual funds in the country. Like the ones in early December, these new rules too are a response to the crisis faced by debt funds during the October and November. In December SEBI moved to shut off the early redemption route out of closed-end funds. It mandated that liquidity should be provided not by the fund companies themselves but by listing them on stock exchanges. The October crisis was precipitated by investors pulling out money from funds whose portfolios were not designed for early redemptions.
Now, SEBI has moved forward another few steps and blocked a range of questionable practices that exist in the debt funds. Firstly, the regulator has banned fund salesmen from stating indicative yields or portfolios to investors. This practice is common in Fixed Maturity Plans. Effectively, fund companies often work out a debt portfolio in consultation with the actual borrowers and then go and hawk this portfolio to investors. Since the portfolio and its yield were known beforehand, these were openly shared with potential investors. During the credit crisis things didn't really work out the way they were supposed to and many funds deviated from the portfolios and underperformed the yields.
SEBI has now banned this mode of working. Obviously, no fund will now publish these indicators publicly. However it remains to be seen whether informal, oral communication of this nature between funds and large investors actually get stopped.
SEBI has also made a set of changes to the rules governing Liquid Funds. These funds are intended for parking money that investors can spare for very short-term periods of times ranging from days to weeks. They are supposed to be run in a maximally risk free manner. This basically means that they should be investing in debt instruments with very short maturity, because such investments react minimally to interest rate changes. During the crisis, it came out that plenty of liquid funds had invested some of their corpus in longer-maturity investments in order to gain some extra returns. Although this would have worked out fine had the crisis not occurred, the very purpose of liquid funds is to ensure that the investments perform as expected regardless of any crisis. As such, what liquid funds were doing was stretch the safety part of their mandate in order to deliver some extra returns.
The regulator has now mandated that liquid fund managers rein in their maximum maturities to six months by February 1 and further to three months by May 1. They are supposed to get out of all those securities that are over these limits. This will go a long way in giving these funds the kind of safety level that they should have. Yet another change that SEBI has done is a more curious one. There is a class of funds that is called 'Liquid Plus' funds. SEBI wants their names changed to something else because, in the words of the circular, 'the nomenclature of "Liquid Plus Scheme" should be discontinued since it gives a wrong impression of added liquidity'. Liquid Plus schemes actually have less liquidity and the 'plus' part refers to the fact that they try and give greater returns than vanilla liquid funds. Liquid Plus funds are also more tax-efficient than liquid funds.
I would have thought that both these category of funds are primarily used by professional investors who wouldn't be misled by nomenclature but anyhow, greater transparency is always welcome. It must be pointed out that all the ills that these rules plug loopholes that basically allowed fund managers to serve up higher returns to investors who wanted those returns. Like the rest of the financial world, neither of the two were overly mindful of risk. Now, having received the fright of their lives, everyone will stay well within limits till the next cycle starts.
Now, SEBI has moved forward another few steps and blocked a range of questionable practices that exist in the debt funds. Firstly, the regulator has banned fund salesmen from stating indicative yields or portfolios to investors. This practice is common in Fixed Maturity Plans. Effectively, fund companies often work out a debt portfolio in consultation with the actual borrowers and then go and hawk this portfolio to investors. Since the portfolio and its yield were known beforehand, these were openly shared with potential investors. During the credit crisis things didn't really work out the way they were supposed to and many funds deviated from the portfolios and underperformed the yields.
SEBI has now banned this mode of working. Obviously, no fund will now publish these indicators publicly. However it remains to be seen whether informal, oral communication of this nature between funds and large investors actually get stopped.
SEBI has also made a set of changes to the rules governing Liquid Funds. These funds are intended for parking money that investors can spare for very short-term periods of times ranging from days to weeks. They are supposed to be run in a maximally risk free manner. This basically means that they should be investing in debt instruments with very short maturity, because such investments react minimally to interest rate changes. During the crisis, it came out that plenty of liquid funds had invested some of their corpus in longer-maturity investments in order to gain some extra returns. Although this would have worked out fine had the crisis not occurred, the very purpose of liquid funds is to ensure that the investments perform as expected regardless of any crisis. As such, what liquid funds were doing was stretch the safety part of their mandate in order to deliver some extra returns.
The regulator has now mandated that liquid fund managers rein in their maximum maturities to six months by February 1 and further to three months by May 1. They are supposed to get out of all those securities that are over these limits. This will go a long way in giving these funds the kind of safety level that they should have. Yet another change that SEBI has done is a more curious one. There is a class of funds that is called 'Liquid Plus' funds. SEBI wants their names changed to something else because, in the words of the circular, 'the nomenclature of "Liquid Plus Scheme" should be discontinued since it gives a wrong impression of added liquidity'. Liquid Plus schemes actually have less liquidity and the 'plus' part refers to the fact that they try and give greater returns than vanilla liquid funds. Liquid Plus funds are also more tax-efficient than liquid funds.
I would have thought that both these category of funds are primarily used by professional investors who wouldn't be misled by nomenclature but anyhow, greater transparency is always welcome. It must be pointed out that all the ills that these rules plug loopholes that basically allowed fund managers to serve up higher returns to investors who wanted those returns. Like the rest of the financial world, neither of the two were overly mindful of risk. Now, having received the fright of their lives, everyone will stay well within limits till the next cycle starts.
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