New valuation norms to raise Liquid Plus schemes’ volatility

The new valuation norms, which mandate fund houses to mark-to-market securities with a maturity of over 91 days in the Liquid Plus category of mutual funds, may increase volatility in these schemes.

Asset management companies (AMCs) are now gearing up to revamp their investment strategies to ensure that volatility is curtailed without compromising on the tax arbitrage enjoyed by the Liquid Plus category of funds.

While there has not been any immediate adverse impact of the new ruling on the assets managed by fund houses under Liquid and Liquid Plus categories, there may be concerns in the future, if there is high volatility in the money market. It is, thus, important for fund managers to insulate these products so as to retain their large-ticket institutional investors.

“One likely change in the investment strategy can be to incorporate a higher percentage of securities with less than a 91-day maturity in Liquid Plus schemes,” says Mahendra Jajoo, ED & CIO (fixed income), Pramerica Asset Management. “This would reduce the volatility of the portfolio which will otherwise be marked-to-market for securities with maturities higher than 91 days,” he adds.

This new strategy, which fund managers may now look forward to, will, in fact, act as a double-edged sword. On one hand, Liquid Plus schemes will run like any other liquid scheme, on the other hand, investors will continue to enjoy the tax arbitrage applicable to Liquid Plus schemes.

Liquid Plus schemes currently attract a dividend distribution tax (DDT) of nearly 22.7% against 28.3% DDT applicable to the Liquid category of funds. It’s for this reason that many institutional investors prefer Liquid Plus to Liquid schemes. Moreover, as the Liquid Plus category invests in papers with a maturity higher than 91 days, their returns are relatively superior to Liquid schemes which invest in papers with less than a 91-day maturity.

Over the past one year, Liquid schemes have generated an average of around 4% returns while Liquid Plus schemes have generated about 6% returns during the same period. For large institutional investors, with investments running in crores of rupees in these schemes, this differential of 200 basis points is quite significant.

The popularity enjoyed by Liquid Plus schemes is also evident from the assets managed by these schemes vis-à-vis Liquid schemes. By the end of June ’10, Liquid Plus schemes managed assets worth around `1.9-lakh crore against `66,000 crore by Liquid schemes.

Thus, with new valuation guidelines directing the securities in Liquid Plus schemes to be marked-to-market have raised more concerns among investors of these schemes.

The new investment strategy, to run Liquid Plus schemes like any other Liquid scheme, will reduce the volatility of the portfolio, but will also mean that investors may have to compromise on returns that accrue to securities with higher maturities. However, this may not be an immediate concern since currently the yield curve being flat — both short and long duration securities are earning relatively similar yields.

“Going forward, however, the industry may see the category of Liquid Plus schemes being sub-categorised as those with maturity of less than 91 days, carrying a lower risk and volatility and those with securities more than 91 days and up to one year, which will be marked-to-market, will be construed to be more volatile,” says a fund manager from the industry who did not wish to be named.

Source: http://economictimes.indiatimes.com/personal-finance/mutual-funds/mf-news/New-valuation-norms-to-raise-Liquid-Plus-schemes-volatility/articleshow/6258917.cms