FUND FLAVOUR

December 2012

Low penetration despite performance…

Debt funds have been around in the Indian market for several years now. However, the penetration of debt mutual funds among retail investors remains quite dismal. Data from AMFI shows that retail investors account for a negligible portion – about 5-10% of the overall assets in most debt fund categories. In some categories like liquid funds, retail investment accounts for just 1% of the category assets. Meanwhile, retail investment in equity funds has grown over the years and presently accounts for about 68% of assets of all equity oriented funds. This is despite the fact that debt mutual funds across categories and tenure performed well in 2012.

Gilt Funds

Gilt funds are good vehicles to play downward movement in interest rate cycle. Gilt funds invest in government securities that have little default risk. Though there is no default risk, a gilt fund investor faces the interest rate risk, wherein a fund may offer losses if the yields move up drastically in the short term. These are ideal for those who want more safety for their investments or are risk-averse and, at the same time, are looking for reasonable returns on their money. According to mutual fund rating agency, Value Research, medium and long-term gilt funds gave returns of 3.84% for the year ended May 30, 2012. In the short-term (less than a year), they have returned 4.18%. Gilt funds were the best performers across categories during the quarter ended June 2012. Gilt funds returned 3.1% over the quarter, outperforming both equity and other debt oriented categories. This was mainly on account of the softening of yields on the back of the Reserve Bank of India reducing the repo rate by 50 basis points (bps) to 8% in its Annual Monetary Policy for 2012-13 in April 2012. Compared to the gilt funds, equity funds returned 1.4% during the quarter, while the S&P CNX Nifty index was up 1.9% and the S&P CNX 500 index was up 1.1%. The higher returns from gilt funds failed to translate into increase in AUM for the category. For the quarter ended June 2012, the average AUM of gilt funds analyzed fell by 13% to Rs 2,574 crore, compared to Rs 2,968 crore in the previous quarter. This was primarily because investors were uncertain about the pace at which the central bank would reduce interest rates. Post the repo rate reduction in April 2012, the RBI retained key policy rates at its mid-quarter policy review in June 2012, giving priority to inflation over growth. Thus, even though gilt funds outperformed other categories, investor interest in this category was muted. Total assets under management under 40 gilt funds stand at Rs 4393 crore, as on October 31, 2012.

Fixed Maturity Plans

The whirring volatility in the stock market has seen many investors rush to the safety of debt instruments like Fixed Maturity Plans (FMPs). Most people are drawn in by the high returns and the superior tax efficiency that they offer compared to that of other debt options such as fixed deposits (FDs). Fixed maturity plans appeared to lose some of their charm among investors during May- June 2012. Indeed, a few fund houses had to withdraw their issuances for want of investors. Inability on the part of fund houses to mobilise the SEBI-mandated 'minimum target amount' of Rs 20 crore was one of the reasons for fund houses withdrawing their fixed term plans. Moreover, many fund houses could not meet the mandatory '20 investors' norm. As per SEBI guidelines, individual FMPs should have a minimum of 20 investors and no single investor shall account for more than 25% of the fund. Apart from about 20 FMP  cancellations, fund houses like ICICI Mutual, L&T Mutual, Tata Mutual, UTI, DWS and Reliance Mutual Fund among others, had to extend their subscription phase to pool in necessary investments and the required number of investors. Now, FMPs are back in vogue. Corporate treasuries are the biggest category of investors in fixed maturity plans. Declining surpluses, over the past few months, have forced corporate investors to cut back their investments in FMPs. However, fund managers feel, short-term debt products like FMPs still offer handsome investment opportunities from a risk-return trade-off perspective. To make up for the shortfall, fund marketers are now pushing fixed term plans to retail investors.

Liquid funds

Liquid funds are getting increasingly popular these days because of the high interest rates, safety, and tax advantage that they offer. Liquid funds invest in treasury bills, government securities, call money, repo and reverse repos and other such instruments that are quite safe in nature and have a short maturity. This means that they are good for parking that part of your money that you would have otherwise put in a bank savings account. Last year has been particularly good for liquid funds, and that is beginning to show in the fund inflows as well. During the month of May 2012, liquid funds had the largest inflow of funds in any category and the inflow was a massive Rs 26,742 crores. The liquid fund category has given average returns of 8.2% over the last one year, according to data from Value Research, an independent provider of mutual fund data and investment information. Meanwhile, savings accounts gave returns of 4%.

…could low risk be the answer?

In its efforts to reduce debt mutual funds’ overexposure to specific sectors, the Securities and Exchange Board of India (SEBI) has imposed a sector cap on the debt mutual fund schemes since SEBI observed that several debt funds, especially Fixed Maturity Plans, were taking huge exposure to specific sectors, raising worries about systemic risk. Each fund house used to decide how much it invests, in which sector. The advisory committee has recommended a cap on debt schemes’ exposure to any sector at 30% within a period of one year. The aim is to reduce exposure of debt schemes to non-banking finance companies (NBFC), as they have the largest exposure, followed by banking and Public Sector Undertakings (PSUs). This could lower the risk of debt fund investing, thereby, increasing its penetration among retail investors.