AMCs park liquid-plus funds into group firms

A few asset management companies (AMCs) are learnt to have transferred a slice of their holdings in liquid-plus schemes to the books of their group companies, to avoid potential losses that could arise from the stricter mark-to-market rule for debt securities that has become effective since August 1. The new rule requires fund houses to mark the prices of the securities with maturities of over 91 days, to market rates.

Liquid-plus schemes have a maturity of more than 91 days, while liquid schemes invest in debt instruments with maturity of less than 91 days.

By selling the bonds to the group company, the risk of volatility will be transferred to the books of the division buying those bonds. Closer to maturity, the transaction will be reversed.

“The transaction as such is not illegal, but a few months later, these funds will be going around bragging to potential investors that their schemes were the least volatile,” said an industry observer, adding that smaller fund houses will not be able to do such deals. “That is misleading the investors,” the person said.

Last week, fund houses had approached Sebi, requesting the regulator for an extension of the August 1 deadline for the new debt valuation norms. The general perception is that interest rates are likely to rise in the near term. When interest rates rise, bond prices fall, and this impacts the net asset value (NAV) of bond funds. Fund managers are worried that a decline in NAVs could spark off a vicious circle, as investors redeem their money, forcing fund managers to sell the bonds at a discount, which in turn causes the NAVs to decline further.

Roughly, a third of the Rs 6.72 lakh crore managed by the mutual fund industry is in liquid plus schemes. A liquid-plus scheme is more popular than liquid schemes, as they offer better returns and are taxed at a lower rate. A dividend distribution tax of 28.33% is charged on liquid funds while it is 22% for other debt schemes, including liquid plus schemes.

Such arrangements were common during the meltdown in money market mutual funds in late 2008, when mutual funds had heavily invested in the bonds of real estate companies. When the property market soured, real estate companies were unable to redeem their bonds. Many investors suffered a loss on their capital —something unusual for debt schemes — as the bonds had to be sold at a loss. Compounding the fund managers’ woes was the illiquid nature of bonds.

Faced with no buyers, many fund houses got their parent companies to buy out their unsaleable bond portfolios.

Some industry players feel a volatility rating, which is prevalent in international markets, could check such deals. That is because rating agencies that issue the grade, also conduct random checks on the portfolio to ensure that all rules are being adhered to.

Source: http://economictimes.indiatimes.com/personal-finance/mutual-funds/mf-news/AMCs-park-liquid-plus-funds-into-group-firms/articleshow/6254317.cms