FUND FULCRUM - DECEMBER 2008

FUND FULCRUM (contd.)

(December 2008)

Ever since mutual funds caught the fancy of the Indian investors, they used to be a means of gain for investors in both good and bad times. But 2008 was different.

A sprawling global crisis of confidence emerged during 2008, dragging financial markets into unprecedented levels of volatility. The year began with a U.S. housing market correction already in progress. Falling housing prices, rising mortgage default and foreclosure rates, and financial-sector write-downs tied to mortgage-backed securities were all elements of this correction that gained momentum throughout 2008. The presence of deteriorating mortgage assets on the books of commercial and investment banks plus instability fueled by credit default swaps led to takeovers, bankruptcies and government intervention among financial firms.

Indian mutual funds became poorer by about Rs 1,50,000 crore, or about one-third of their total size. So did the investor’s kitty…

Piquant Parade

At a time when the mutual fund industry is reeling under the pressure of recessionary tendencies, Kolkata-based Peerless General Finance & Investment Company Limited, the first financial services company in Eastern India, has got preliminary in-principle approval from SEBI to set up an asset management company.

Cost cutting comes automatically in times of falling AUMs. Fund houses have begun negotiating with brokers, custodians and transfer agents to lower service charges. Several brokers, on their part, have reduced dealing charges (for institutions) from 0.25% to as low as 0.10% of the total transaction size.

On the other hand, in a bid to bolster their sagging AUMs, mutual fund houses are pampering distribution agents with unique incentives to boost sales. Fund houses are handing out upfront commission and monetary remuneration to increase fund sales. In addition to the 2.25% as entry load and 0.5% trail commission, distributors are being offered 0.5% extra commission for every fund sold. Instead of annual commission, which was the case until some time ago, fund houses are now offering an upfront commission of 1% for selling gilt and income funds.

Regulatory Rigmarole

SEBI has made the listing of all close-ended mutual fund schemes (except equity-linked schemes) that are launched on or after December 12 mandatory. Since the trading of units takes place only on the exchange, NAVs will not be impacted. Investors who stay on in the scheme are protected to a great extent and the fund manager is also not forced to sell securities before maturity at a huge discount, as is the case now when large investors in close ended schemes pull out. However, there will be a listing cost involved in the form of listing fees which may be recovered from the investors in the scheme. These will be part of the expenses for the fund, but will be lower than the exit load. For close ended schemes, the underlying assets will not have a maturity beyond the date on which the scheme expires. The new norms have come in wake of a liquidity crisis faced by the mutual fund industry when investors heavily redeemed from fixed income funds fearing their credit quality after rumors that funds had invested in commercial papers of real estate companies and NBFCs who were unable to pay them back.

New tougher norms are likely to be created for Fixed Maturity Plans (FMPs) if SEBI accepts the recommendations of AMFI. FMP schemes, which have a maturity between one and three months, must have a minimum 30% allocation to cash, collateralised borrowing and lending obligations (CBLO), bank fixed deposits, treasury bills and others - all safe and liquid instruments. In addition, AMFI has recommended that 30% of the investment can be made in bank fixed deposits against a present norm of 15% in bank FDs and 20% with board approval. Moreover, the maturity-mismatch has to be contained at 10% of the tenure of the instrument or one month, whichever is lower. AMFI has also recommended that all fixed-rate instruments above three months (instead of six months at present) should be marked to market. For debt funds, the valuation of the underlying papers is currently based on CRISIL`s valuation matrix. AMFI has proposed outsourcing these valuations to an independent third party. The Securities and Exchange Board of India in its board meeting today decided to fix the structural flaw in fixed maturity plans. It was decided that no early exit will be allowed in any scheme of mutual fund in the nature of a closed-end scheme. The schemes which have been approved earlier but not yet launched will also have to be amended accordingly.

The issue of sectoral caps on mutual fund investments has come up for discussion. Company-wise and industry-wise caps are being discussed by the Association of Mutual Funds in India. Some funds have over 90 per cent exposure to the banking and financial services sector. With real estate stocks facing the brunt of the meltdown, SEBI is likely to take steps to discourage mutual funds’ high exposure to the real estate sector.

The Securities and Exchange Board of India is discussing the issue of increasing the borrowing limit of a mutual fund from the existing 20 per cent to 40 per cent of the net assets of a scheme for a six-month period. This is to enable them to meet temporary liquidity needs like repurchase, redemptions or payment of interest or dividend. In order to meet sudden redemption pressures, liquid funds may be disallowed from holding securities with a maturity exceeding 90 days.

SEBI is set to discontinue the differential loads on high-value investments, in an attempt to provide a level-playing field to mutual fund investors. The move will balance the load for retail investors, who often end up subsidising their institutional counterparts.

The mutual fund advisory committee to SEBI, headed by S A Dave, has recommended that investors should pay the commission to distributors directly. As per the current norm, the commission is deducted from the total investments in mutual funds. As per the committee, since distributors provide services to investors, the commission should come from the investors themselves. Further the committee feels commission can also be negotiated, depending on the standard of the service.

The Dave committee has recommended that the practice of mutual funds declaring indicative return and indicative portfolio be stopped. However, the market regulator may make it mandatory for funds to disclose their entire portfolios once a month on their websites. Currently, most fund houses do not disclose the extent of exposure they have to pass through certificates (PTCs) and securitised paper.

The committee has discussed hiking the minimum networth requirement for mutual funds from Rs 10 crore to Rs 50 crore and networth of the sponsor to be five times the networth of the fund. However, this may take some time because the advisory committee that includes representations from investors’ associations is divided on this issue. A section of the industry feels that mutual fund is the domain of the fund manager. Raising the networth requirement may hamper individual fund managers from entering the asset management space.The other view is that a strong sponsor can infuse additional capital and provide liquidity support, if required.

Government has allowed navaratnas and miniratnas to invest upto 30% of their surplus in equity through public sector mutual fund schemes. The scheme to allow navratnas and mini-ratnas in this regard expired on August 1 this year, a year after it was notified.

Indian banks, insurance companies and mutual funds will soon have the opportunity to manage pension funds. The Pension Fund Regulatory and Development Authority (PFRDA) sought applications from entities wishing to float pension funds to manage retirement assets of all Indian citizens, other than government employees already covered under the existing pension scheme. Detailed criteria set out by PFRDA in its primary information memorandum (PIM) entitle government institutions, banks, insurance companies and mutual funds to sponsor a pension fund. One important criterion is that the sponsor must have at least five years of experience in running debt and equity funds and should have managed average monthly assets of Rs 8,000 crore for 12 months ended November 30, 2008.

SEBI has asked fund houses to aggressively market debt schemes to retail investors and also to focus on rural markets. According to data compiled by SEBI out of the 44.4 million investors, 87% are from urban centers. The corporate sector accounted for 56.55% of the mutual fund industry's AUM in debt schemes. The share of retail investors was only 6%, with the remaining accounted for by HNIs and other institutional investors.

The weak close to the year 2008 could provide an excellent ground for rebuilding as this is the appropriate time for investors to buy for the long term. Probably on account of this, the industry saw new fund houses entering or planning to enter the space this year. The ensuing year, 2009, could see much more consolidation on the back of declining assets under management and the rising cost of services, when a number of small fund houses could be sold to their bigger rivals. The much-awaited turnaround could also materialize in 2009…..but let us not resort to crystal gazing…..let events unfold at their own pace…..for informed and intelligent investors the opportunities beckon right now!!!

FUND FULCRUM - DECEMBER 2008

FUND FULCRUM
(December 2008)

Indian fund houses would like to forget 2008-09 as they witnessed their assets under management decline by Rs 1,89,898 crore between April (Rs.5,95,010 crore) and November(Rs.4,05,112). The drop can mainly be attributed to the global financial turmoil, leading to a liquidity crunch and prompting investors to pull their money out of mutual fund schemes. However, the AMFI data show that nearly 84 per cent or Rs 25,097 crore of redemptions in September and October — the worst months for fund houses — were as a result of the schemes maturing during those days. Mutual funds are set to witness a fresh round of redemption of Rs 36,848 crore between December 2008 and March 2009, with many of their debt schemes such as fixed maturity plans (FMPs), quarterly and monthly interval plans, fixed horizon plans and money market-related schemes set to mature during the coming months.

During November, redemption pressure on mutual funds came down from 97000 crore in October to 30000 crore. Mutual fund outflows in November were less than one third of outflows recorded in October, and the liquidity situation is improving though there is still investor wariness about equity schemes. Regulators continued with their liquidity support measures along with other confidence building measures. Both SEBI and AMFI confirmed that RBI measures had addressed the mutual fund industry’s liquidity requirements to a large extent. Besides, the special refinancing window for mutual funds (which has now been extended till March 2009), the RBI cut its repo rate by 150 basis points, cash reserve ratio (CRR) by 350 basis points and the statutory liquidity ratio (SLR) by 100 basis points since October to ease liquidity. On December 6, RBI announced another set of rate cuts, i.e., 100 bps cut in the repo rate to 6.50% and 100 bps cut in the reverse repo rate to 5%.

After a huge fall in assets under management of 27% during October (18% in September), the industry has seen a 7% decline in November, almost in line with overall market fall. Reliance Mutual Fund witnessed the biggest fall in its AUM in absolute terms, with an erosion of Rs 3278 crore but it still managed to maintain its coveted numero uno position with an AUM of Rs.67,816 crore. HDFC Mutual Fund maintained its second position intact and recorded a fall of 2.68 per cent in its AUM. UTI Mutual Fund’s assets have risen marginally by Rs 74 crore (0.19 per cent) to Rs 38,358 crore. It has taken over the third position from ICICI Prudential whose AUM stands at Rs 37,055 crore. Most fund houses have seen a decline except for Tata Mutual Fund which has seen a rise of about 3.2% and UTI Mutual Fund which has seen its assets almost stable rising by only 0.2%. Clearly the situation has improved a little for a few fund houses as compared to October but most of the fund houses still see their assets eroding substantially.

Piquant Parade

India's oldest mutual fund, UTI Asset Management Company, is eyeing to divest 26% to a strategic partner. It is reportedly in talks with three potential buyers, which include US-based T Rowe Price and Vanguard Mutual Fund. The buyer is expected to pay Rs 1500 crores to Rs 1800 crores, which would value the AMC at between Rs 6000 crores and Rs 7500 crores. The deal will not require an expansion of capital. Instead, all the four government-owned promoters of UTI AMC - State Bank of India, Punjab National Bank, Bank of Baroda and Life Insurance Corporation of India, will divest their 25% holdings proportionately. All four promoters have given UTI AMC`s management a mandate to find a strategic partner.

Religare Enterprises announced that following the acquisition of 100% share holding in Lotus India Asset Management by Religare Securities, a wholly owned subsidiary of the company, Lotus has become a step down subsidiary of the company. Following the acquisition, the name of Lotus India Asset Management has been changed to Religare Asset Management. The name change is effective from December 16, 2008.

The country’s third-largest private sector lender, Axis Bank, has received in-principle approval from the Securities and Exchange Board of India to set up its own asset management company. The bank is now waiting for the equity markets to stabilise before launching its first fund.

Principal PNB AMC issued a statement reinforcing its confidence in its India business. There have been reports that Principal is in talks with Birla Sun Life AMC to sell its mutual fund operations. The fund house expects the announcement will quell rumours about its operations. In fact, Principal Financial Group is looking to acquire an AMC in India as it wants to scale up its mutual fund operations in India. The company feels that the current market situation is the best time to do an acquisition because of lower valuations commanded by companies.

Edelweiss Asset Management Company entered into a distribution tie-up with Bank of Rajasthan for distribution of its products and services. Under the agreement, Bank of Rajasthan intends to distribute Edelweiss Mutual Fund's products through approximately 100 out of its 463 branches in India. The tie-up will help to strengthen its distribution network and increase its penetration across India.

Morgan Stanley Mutual Fund's flagship equity scheme - the close-ended Growth Fund launched in January 1994 - is set to become open-ended from January 15, 2009. In line with the SEBI guidelines, existing investors will be given an option to redeem the fund at the current NAV without any exit load. They can remain invested or switch fully, or partially, to the only other scheme managed by the fund house, ACE.

Life Insurance Corporation of India (LIC), the government owned insurer has purchased illiquid paper worth Rs 1755 crore from its mutual fund arm LIC Mutual Fund Asset in October. The insurer resorted to this off-market deal with it`s mutual fund arm to provide liquidity to it to meet redemption pressures. The acquired debt included bonds worth Rs 650 crores sold by BPTP, Rs 543 crores by Housing Development and Infrastructure, Rs 195 crores by Unitech and Rs 117 crores by Sobha Developers, among others.

Fidelity Mutual Fund has launched an innovative volatility tool designed to help advisers and investors put the current market uncertainty in the context of a longer term perspective. Fidelity`s volatility tool demonstrates the importance of longer term investing and staying focused on financial goals. The tool available at the website of Fidelity India uses investing truths, up-to-date data and dynamic graphics along with simple design. It is visually engaging and showcases several scenarios and themes that will educate advisers and investors about volatility. The web site has three tools that deal with different aspects of market volatility.
The tools on the website deal with:-
Timing the market : This tool helps investors establish how much they could lose on a notional investment of Rs. 0.10 million if they miss the 10, 20, 30 and 40 best days in the Indian market over a ten-year period.

Unpredictable returns : This tool helps investors look at how volatility increases or dips as investments are held over a one-year to a ten-year period.

Market crises : This section allows investors to check out how long the market took to return to its previous level after various crises.

To be continued.....

NFO Nest - December 2008

NFO Nest
(December 2008)

A silver lining in the dark cloud…

“The SBI Mutual Fund, with an investor base of over 55 lakh and a large network across the country, has mobilised Rs 1,677 crore under SBI Debt Fund Series-90 Day-32 plan that was closed on November 25, 2008. The scheme received good response from both retail and institutional investors with 2,300 applications being received during the New Fund Offer period…” so goes the news item. Today, such a news item in the field of finance is few and far between.

The following funds find their place in the NFO Nest in December, 2008.

Benchmark S& P CNX 500 Fund

Opens: 17 Nov, 2008 Closes: 15 Dec, 2008

Benchmark S&P CNX 500 Fund, India's first passively managed fund tracking the S&P CNX 500, aims at generating capital appreciation through equity investments by investing in securities which are constituents of S&P CNX 500 index in the same proportion as in the index. The fund will have at least 90 per cent exposure in the stocks of its chosen index. In case, it is not able to buy a stock that is stated in the index, then it can have exposure in its derivative instrument of up to 10 per cent. The fund may also invest in various debt instruments like money market instruments, G-Sec, Bonds, Debentures and Cash but it should not be more than 10 per cent of the total net assets.

Popular globally, index funds are yet to attract significant assets in India. Nearly 60 percent of the diversified stock funds have seen their net asset values fall more than the benchmark index's 54 percent fall this year, according to global fund tracker Lipper. Benchmark S&P CNX 500 Fund will be a low cost choice for investors seeking a broad exposure of Indian equity. Index funds can have a maximum expense ratio of 1.5% compared to 2.25% for actively managed funds. This fund is likely to provide one of the the widest equity exposure to investors. The index provides a broad diversification across sectors and industries accounting for nearly 92 per cent of the market capitalization. The case for indexing is getting stronger. In the current market meltdown many funds have collapsed far more than their benchmark, for lack of disciplined investment approach.

IDFC Tax Advantage Fund

Opens: 1 Dec, 2008 Closes: 17 Dec, 2008

IDFC Tax Advantage (ELSS) Fund seeks to generate long-term capital growth from a diversified portfolio of predominantly equity and equity related securities. The scheme will invest in well-managed growth companies that are available at a reasonable value and offer a high return growth potential. Companies would be identified through a systematic process of forecasting earnings based on a deep understanding of the industry growth potential and interaction with company management to access the company’s long term sustainable profit growth. The scheme aims at investing 65% to 100% in equity and equity related securities, 0% to 20% in debt and money market instruments and 0% to 20% in securitized debt instruments. The performance of the scheme will be measured against the BSE 200 index.

Sahara Star Value Fund, Sahara Annual Interval Fund, Sahara Super 20 Fund, Canara Robeco Dynamic Bond Fund, Tata Smart Investment Plan, Birla Sunlife Medium Term Plan, Gilt Benchmark Exchange Traded Scheme, Goldman Sachs India Money Market Fund, ING US Opportunistic Equity Fund, Baroda Liquid Plus Fund and Lotus India Active Nifty Fund are expected to be launched in the coming months.

GEM GAZE - DECEMBER 2008

Gem Gaze

Is the party (banquet for the prodigal son) over?

After four years of subdued existence, debt mutual funds made a sparkling come back in 2007. Diversification to debt is one of the better options available to investors in the current uncertain period in the markets, when equities wilted under the heat of the global financial market meltdown. The superior show by debt funds, led by a sharp rise in bond prices in the past few months, was on hopes that inflation would decline and trigger a spate of interest rate cuts. The bet has turned out to be right so far, but it is uncertain as to whether such a sterling performance can be repeated next year. This is because prices of these bonds are expected to slip on higher-than-estimated borrowing by the government. The government’s borrowing programme for 2008-09 may overshoot its target of 2.5% of gross domestic product (GDP), or Rs 1.33 trillion. Higher government borrowing results in increased supply of bonds, which negatively impacts prices and pushes up yields. In addition to fundamental reasons, smaller fund size (around Rs 150 – 200 crore) would be critical for debt schemes to maintain their performance of 2008.

The Dashing Debt Dynamites of last year have not lost hold of their grip on the Gem status, save one. Principal Income Fund failed to live up to our expectations and has been replaced by the gaiety gait of ICICI Prudential Gilt Fund, with its robust returns.

Birla Sunlife Income Fund Gem

Bounty at the Banquet

Launched in March, 1997, this decade-old fund with an asset base of Rs.194.96 crore (Rs.31.94 crore in June 2007) and an average maturity of 8.28 years, has several awards to its credit. The noteable awards during the past one year include the 2007 CNBC-TV18 CRISIL award, the 2008 Lipper Awards for the Best Fund (3 and 10 years performance) and the ICRA Five Star Award (1 and 3 years performance). Rs 1 lac invested on 8-Dec-2003 in Birla Sun Life Income Fund is worth Rs.135735 as on 5-Dec-2008. A similar investment in the benchmark CRISIL Composite Bond Fund Index would have been worth Rs.118655. The one-year returns are 13.15% as against the category average of 8.69%. With 61.93% invested in Government of India Securities and 25% in AAA rated bonds and 20 % in cash, safety ranks high on the fund’s agenda.

Kotak Bond Regular Fund Gem

Quality quadruples kitty

Kotak Bond Regular Plan, a medium-term, open-ended fund has generated consistent returns since its inception in November 1999, yielding 9.72 per cent per year. For a 1-year period, the fund has delivered returns of 8.58 per cent, which is better than the benchmark’s 5.75 per cent and the peer group’s 6.14 per cent. Kotak Bond Regular has not only generated decent income for its investors, but has done so with a reasonably low level of volatility. It has managed this by investing in quality rated corporate papers keeping 60-70 per cent of its portfolio in high yielding assets such as bonds, commercial paper, corporate deposits and securitised debt. The balance 30-40 per cent is deployed in riskier government securities. The emphasis on a high yield portfolio and spreading the risk across a wide maturity horizon and different kinds of issuers in debt markets has helped keep the fund’s volatility low. At the same time, no opportunity has been lost to book gains when the market has provided profit booking opportunities. Besides, savvy short-term calls in the g-sec market have helped the fund generate superior returns. The g-sec exposure doubles up as a means to address redemption pressures, thanks to relatively high liquidity in that market. On the other side of the spectrum, instruments such as securitised debt are used to increase the average yield of the portfolio. This is despite the fact that such instruments are illiquid. But then, securitised debt accounts for only about 14 per cent of the portfolio, and even in a case of redemption pressure there may be no need to liquidate this part of the portfolio. The expense ratio of 0.89 per cent is very impressive and is significantly lower than the category average. But now, the expense ratio stands at an all-time high of 2.25% in view of the active interest rate bets taken by the fund. The scheme currently managed assets worth Rs 37.46 crore. It has seen outflows in the last couple of quarters. This erosion in fund size is attributed to the overall trend in the debt market. In a nutshell, Kotak Bond Regular is a reliable fund which delivers high returns, with about average volatility. A reduction in expenses will make it a truly quality offering.

LIC Bond Fund Gem

Lean Lead

This medium-term, open-ended debt fund, launched in November, 1999 has an asset base of Rs. 58.42 crores. Its one-year return has been 11.25 % as against the category average of 8.69%. With 43.3% of its assets in Government of India securities, 49.52% in Debentures (20% in AAA rated papers) and 8.46% in Structured Obligation, safety seems to be the overriding concern.

UTI Bond Fund Gem
Upholding Ubiquity
Launched in May 04, 1998, the fund aims at providing regular savings facility, easy liquidity and attractive post-tax returns to the investors through capital appreciation. It has an asset base of Rs. 215.18 crore with 41.66 % in Government of India Securities, 27.4% in NCDs, 25.37% in Debentures and Bonds and 5.57% in current assets. Its 1 year return is 9.72% relative to 2.68% of the benchmark J.P.Morgan Indian Government Bond Composite Index.

ICICI Prudential Gilt Investment In

Gaining Ground

The 2008 Lipper Award winning ICICI Prudential Gilt Investment Plan has generated an annualised return of 12.2 per cent and has consistently outperformed the benchmark I Sec I-Bex by a comfortable margin since its inception in August 1999 and this period spans varying trends in the interest rate cycle. Even as equity markets were struggling to generate a positive return, ICICI Prudential Gilt has piggybacked on rising gilt prices to generate a return of 25.3 per cent over a one-year period as against the category average of 15.7 per cent. A major part of this return has been achieved during the past few months, amid the sharp slide in yields. Though returns of this order may not be repeated, returns are likely to remain healthy (in the 10-11 per cent range) over the next one year, given the softening bias to interest rates. According to the November portfolio, the fund had 91.6 per cent in long-term bonds (above 10-year maturity), 3 per cent in CDs and term deposits and the balance in money markets and other assets. The preference for long-dated securities, reflected in the 10-year yield-to-maturity, has dropped from a high of 9.5 per cent to 6.7 per cent. The softening of inflation and the anticipated cut in interest rates have pushed down yields and helped prices of long-term bonds over the past six months. The fund intends to hold 70 per cent of the assets in long term instruments and 25-30 per cent will be churned to generate higher yields. With the interest rate heading south, ICICI Pru Gilt Investment has a potential to generate better returns. A conservative investor might find the liquidity of the fund and the sovereign guarantee that backs its securities attractive. Those in the higher tax brackets may also find it a tax efficient way to earn debt returns.

The equity market has belied investors’ hope of a quick revival, what with the correction that started in January 2008, showing no clear signs of waning. However, given the interest rate movement over this period, those who had invested in debt funds would have derived some comfort. Whether this cushion will remain soft or hurt in 2009 remains to be seen…

FUND FLAVOUR - DECEMBER 2008

FUND FLAVOUR

Debt Funds

Dime (Debt Funds) a dozen…


Mutual funds offer a wide bouquet of debt funds. The recent hardening of interest rates has opened up a lot of opportunities for those looking to invest in debt instruments. Depending upon your investment horizon, tax status and liquidity needs, you can make your choice. Of course, no investment is without risk. But as long as you make an informed investment, you can minimize the risks and maximize the returns.

Here is a look at the different avenues in debt instruments and how they have fared in the year gone by…

Gilt Funds

G(u)ilt free edge…

In October 2008, the mutual fund industry witnessed a massive loss in its average assets under management (AAUM) of over Rs 97,000 crore. However, a small segment of debt schemes managed to buck the trend — gilt funds. We have witnessed aggressive monetary easing across the globe in response to the credit crisis... In India, RBI has also cut its key rates in recent months to ease liquidity pressures. This has led to a decline in bond yields, helping the performance of gilt funds. Over the past one year, till October 24, 2008, medium- and long-term gilt funds have been the best performing category among debt funds. Some top-rated gilt funds are giving a return of over 20 per cent. Short-term gilt funds collected the maximum, over Rs 1,500 crore, and the medium- and long-term category netted another Rs 70 crore. In fact, the short-term category’s AAUM is up from a paltry Rs 501 crore to Rs 2,018 crore. While the medium-and-long-term (over one year) category average returns is at 9 per cent, some of the bigger funds have been able to give really good returns — ICICI Prudential Gilt Investment (17.15 per cent), many others have given returns between 14 and 16 per cent. Even the short-term gilt category (less than a year) has given returns of 6.44 per cent.

Fixed Maturity Plans

The Blockbuster goes bust…

In September 2008, returns were on the upswing, thanks to tighter liquidity conditions. FMPs launched in September were offering indicative returns (mutual funds can only indicate and not guarantee returns) of around 11 per cent for both short- and the long-term FMPs. This has now come down to the range of 9.95-11.10 per cent. However, this is still higher than the returns indicated by funds over a year ago. In September 2007, three-month FMPs’ indicative rates were around 8-8.30 per cent, and for over 12 months, they were hovering around 9-9.50 per cent. While the longer duration FMPs are still indicating returns of around 10.5 per cent, the shorter duration ones have begun downward revisions in the indicative yields.

A downward revision in the returns coupled with concerns over the quality of the paper held by FMPs has led to retail investors shying away from FMPs now. This was attributed to the fact that many of them had invested significantly in commercial papers (CPs) and bonds of real estate companies and non-banking financial institutions (NBFCs).There were strong rumours that many of these companies were unable to repay the fund houses on time, leading to rollover of schemes. This fuelled fears that many schemes would be forced to default. When all fund houses declared portfolios of their schemes because of the half-yearly results, it dawned on the investors that the real portfolios were a far cry from the indicative portfolios.

FMPs faced severe redemption pressures in October, 2008 a month which saw the Bombay Stock Exchange’s benchmark Sensex fall a record 23 per cent. According to October-end data, the average assets under management (AAUM) of FMPs stood at Rs 127,080 crore, down Rs 10,718 crore in a single month. Over 25 per cent of the entire AAUM of the mutual fund industry is in this one product. SEBI confirmed that it will make early withdrawals from FMPs tougher, a move that is expected to solve mutual funds’ liquidity problems. At present, investors can exit FMPs by paying 2 per cent of the NAV at any point of time.

Debt Income Funds

Indebted…

The performance of debt income funds has not been very inspiring of late. In fact, even short-term income funds have outperformed longer-term income funds. This is because fund managers of income funds buy debt instruments of varying maturities. In a rising interest rate regime, the market price of bonds fall, as their yields rise, especially those of longer maturities, making longer term debt portfolios suffer a mark to market loss. In the past year short-term income funds have returned 6.68 per cent while long-term debt funds have returned only 5.32 per cent. This avenue of investment does not look very attractive in a rising interest rate scenario. These funds are ideal for people on the verge of retirement or those with moderate risk appetite.

Floating Rate Debt Funds

No longer floating…

Floating rate debt funds are linked to floating rate of return, which change with bond yields and interest rates fluctuations. This means that ideally, floating rate funds should not incur a mark to market loss on their debt portfolio in a rising interest rate scenario. However, returns of these funds have been quite low, with short-term funds returning more at 7.05 per cent than longer-term funds at 6.88 per cent. These funds have given an average return of about 7-8% over the last 6 months to 1 year, which on post-tax basis works out to about 6.15-7%. Similar have been the FD rates; but the post-tax returns work out to around 5.3-6.1%. Though these funds are a better choice over debt income funds in the present scenario, their returns do not make them a preferred vehicle of investment for longer-term investments.

Liquid Funds

Melting in the mouth…

Liquid funds have traditionally experienced considerable volatility in their assets, as their key investors are institutions and corporate treasuries rather than retail investors. Redemptions from liquid funds spiked in March, June and September 2008, following historical patterns as these are months when companies may need additional liquidity to pay taxes and advance taxes. However, redemptions this year have also been influenced by tightening liquidity over the past four months, corporates facing a funds crunch and an investor flight to safety. In the last one year, liquid funds have returned between 7.7 per cent and 8.85 per cent. Liquid-plus funds, on the other hand, have slightly higher returns between 8.4 and 11.29 per cent. Obviously, that makes them a better choice as against money earning a dismal 3-3.5 per cent in your savings account. But worries about a deteriorating credit environment have led to corporates and institutions moving to fixed return investments such as fixed and bulk deposits as also hard cash. Interest rates on alternatives such as bank deposits started to rise sharply in the second half of the year. These offered attractive and safer options, atleast for high net worth investors, which may explain some of these non-seasonal redemptions.

Concern of the conservatives…

Debt is not a homogeneous set of assets. This variety offers much better control over returns and risks compared to equity, and is thus ideally suited for the more conservative investors. This image of debt funds have taken a severe beating in recent times. In some of the papers, yields on the securities have crossed 50%, which is an indication that the market is beginning to price in a possible default risk on these investments. The bonds are quoting at yields of 27-60% against 12-16% a year ago. A few portfolio managers could well be investing a slice of their corpus in these papers. So how do these discounts or higher yields affect a company’s profile over a period of time? If bonds trade at a huge discount to their issue price for a sustained period of time, it will certainly affect the company’s ratings. A concern indeed for the diehard conservatives.