Covid-19, FII sell-off hit liquid funds hard; RBI's LTRO may calm investors

The total outflow from mutual funds went up to Rs 2.35 trillion till March 29; bond yield spike led to redemption pressure

Assets under management (AUM) of the Rs 27-trillion mutual fund industry took a huge knock in March, largely because of withdrawals from the debt and arbitrage funds.
 

The outflow from mutual funds went up to Rs 2.35 trillion till March 29, industry players said, quoting data. The net outflow in short-term funds, they said, was close to Rs 1 trillion. Besides, some more selling took place in the last couple of days of the month.
 

Debt funds, especially liquid funds, were also impacted owing to a spike in bond yields. Industry players said several factors came into play simultaneously — aggressive selling from foreign institutional investors in the short-term bond market, inability of many brokers to trade actively, sales by companies for advance tax, and a huge expectation that the Reserve Bank of India (RBI) would cut rates and open a special window on March 20.
 

However, things turned worse as the RBI took no such decision on that date. Liquid fund yields spiked by 150-170 basis points and reduced the bond prices, leading to negative returns in liquid funds. Companies, which account for over 90 per cent of the Rs 16-trillion liquid fund AUM, rushed to redeem. “In addition, there were worries about the Covid-19 crisis hurting finances, accentuating the selling pressure on liquid funds. We expect an additional Rs 70,000 crore to Rs 80,000 crore outflows due to this crisis — the worst in many years,” said the CEO of a fund house.
 

Usually, there is a net outflow from liquid funds during the end of the year because companies withdraw money to pay advance taxes. However, industry experts like Dhirendra Kumar, CEO, Value Research, explained that the pressure of paying advance taxes wasn’t very high this year because of the tax relaxation given by the government last September.
 

With huge outflows, fund managers were forced to raise more cash to meet redemption pressure.

“It has been a tough couple of weeks because we’ve had to convince investors not to withdraw or constantly raise money to meet the pressure,” said an industry CEO.

While the mutual fund industry through its industry body, the Association of Mutual Funds in India, approached the RBI, seeking a special window, as it was done in 2009 and 2013, the central bank did not do so. Instead, it announced the long-term repo operations, or LTRO, of Rs 1 trillion on March 27. With the RBI lending at 4.4 per cent, and existing commercial paper and certificate of deposits going at 6 per cent, banks will be encouraged to invest in them. This will ease pressure on mutual funds that need money to redeem.

Things were quite bad before the rate cut was announced. Banks were lending to the RBI at 5.14 per cent (reverse repo), but unwilling to invest in certificate of deposits or commercial papers of well-known banks at even 9-10 per cent.
 

“After the RBI policy announcement, negative returns in fixed income instruments are not a concern, especially in liquid and short-duration schemes. Short-term rates will remain low now, given high liquidity and also deposit rate cuts by banks,” said A Balasubramanian, CEO, Birla Sun Life Mutual Fund.
 

Agreed K Harihar, treasurer at FirstRand Bank: “Inflation seems to have peaked and there is around Rs 4 trillion liquidity overhang in the system. This should keep rates under control unless the government overshoots the borrowing programme significantly.”
 

Though equity inflows were positive during the month, the bloodbath in the markets hit the overall AUM by almost 25 per cent. Industry players say the AUM of equities stood at around Rs 8 trillion, down from Rs 11.45 trillion.
 

But one category -- arbitrage funds -- took a serious knock. The panic was caused in the third week of the month when arbitrage funds saw heavy redemptions due to the absence of any opportunity in the market. Nilesh Shah, managing director, Kotak Mutual Fund, said: “There was an unusual spike in arbitrage fund redemptions as some fund managers gave a call looking at negative spread in the third week of March.” Consequently, there was panic-selling among investors to the tune of over Rs 30,000 crore, reducing the AUM by almost 50 per cent. “Fortunately in the fourth week, spreads turned positive, allowing us to deploy our funds at good spreads. Arbitrage funds provide an attractive opportunity to invest, as daily volatility in many stocks is more than what an arbitrageur will pay in carry cost over a year,” he added.