Tight liquidity, redemption risks make mutual funds look to banks for funds

Fund houses say IL&FS crisis needs urgent credible measures to ensure no further defaults, lower risk of contagion impact

The tight liquidity environment has made it difficult for mutual funds (MFs) to offload commercial papers of duration as low as one or two days. Some large fund houses are even looking to borrow from banks to meet the incremental redemption requests, said people in the know.

“The situation is quite precarious, if not as serious as 2008. Trading in the secondary market has almost dried up. In current conditions, no borrower will tap primary markets with rates all over the place. Certificate of deposit rates are two per cent higher than overnight rates. If this situation does not improve, the spillover effect can extend beyond NBFCs (non-banking financial companies) and manufacturing firms can also soon start facing the heat,” said Lakshmi Iyer, chief investment officer, debt, Kotak Mutual Fund.

Top officials of fund houses say that the IL&FS crisis needs urgent credible measures to ensure no further defaults and lower risk of contagion impact.

At present, MFs can borrow up to 20 per cent of their net assets for six months to meet redemptions, repurchase, and pay interest and dividends to unit holders. This allows fund houses to borrow from banks an amount that is directly proportional to their assets under management (AUM) in a particular category. This means if the liquid asset of a fund house is Rs 1 billion, the fund house can borrow Rs 200 million to meet redemption needs.

“Liquidity has dried up, but we have not seen any major redemption pressure. Having said that, it’s a difficult market for a seller,” said a debt fund manager.

Three-month commercial paper (CP) rates have hardened by as much as 50-75 basis points on low volumes in the past week. The hardening of yields has dissuaded new CP issuers from hitting the market. Analysts at a leading domestic brokerage expect the benchmark 10-year government paper to trade in a broad range of 7.75-8.25 per cent in the second half of 2018-19. 

“We believe the recent squeeze in money market liquidity has mostly been on the back of portfolio adjustments in debt funds, which had a relatively larger exposure to specific entities. While, as of now, we assign a low probability to a full-fledged liquidity crisis, the pressure in the NBFC debt space may continue for some time with the consequent hardening of short-term rates,” analysts said. 

MFs have deployed 17 per cent of their debt AUM in NBFCs, as per estimates.

On Monday, DSP MF officials held a call with investors to allay their concerns and said the selling of Dewan Housing’s debt paper didn’t have much impact on the scheme. However, the officials did express concern over the recent developments in the corporate bond market.

“If a group such as IL&FS with such a good parentage faces this situation, it is a concern,” officials said, adding regulatory intervention was needed.

Recently, DSP MF sold debt papers of Dewan Housing at a yield of 11 per cent. Fund managers point out this indicates the tightening of liquidity; as such papers typically trade between 8 and 9 per cent.

The MF industry is also worried that if timely intervention doesn’t come through, redemptions could surge. Corporate investors account for more than half of the Rs 7.6-trillion debt-oriented schemes. Experts say any sharp pull-back from them could trigger heavy redemption pressure for the industry. Investor sentiment on debt schemes was already weak, with such plans seeing a net outflow of more than Rs 500 billion in this fiscal year amid hardening yields.