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Indian Liquid Funds “break the buck”


From Value Research Online: Reserve Bank comes to the support of Cash Funds:

RBI has decided to provide a temporary credit line to funds to enable them to bridge the gap between redemption requests and the sale of underlying securities.
The move comes in the shape of a special Rs 20,000 crore credit line to banks which is to be used to provide 14-day credit to funds. The central bank will conduct a special 14 day repo at 9 per cent per annum for the notified amount of Rs.20,000 crore.

Last Friday, something unprecedented happened-some mutual funds of the ‘Liquid Plus’ type made a loss over the previous day, i.e., their NAVs for Friday were actually lower than their NAVs for the Wednesday, the previous day when the markets were open. The number of funds affected were not large-in all about five funds out of 36 showed a loss.
These losses are important for two reasons. One, this type of funds is supposed to be an ultra-safe one that shouldn’t have any losses ever. And two, this could well be the harbinger of a deeper problem that could become serious over the next few days. In the coming days, perhaps as early as Monday, the same problems could hit cash funds and perhaps some other debt categories also.

Over the last few days, it appears that fund companies have had trouble making redemptions because the underlying instruments are becoming difficult to sell. The deep risk aversion and credit worries that have gripped financial markets have meant that debt assets that should have been easy to sell have proven near impossible to sell.
On Friday, a few fund companies seem to have honoured redemptions by selling some investments at whatever price they could get. This price was obviously lower than what the instruments were valued at. As a result, NAV has dropped and the funds’ investors have borne losses. The losses may look tiny to equity investors but they are a big deal for liquid funds. The root cause is that liquid funds were being bought under the assumption that their risks were negligible. However, negligible does not mean zero.

Liquid “plus” funds losing NAV? Where did I hear that last? Uhem – here it is. November 2007: GE’s “enhanced” cash fund breaks the buck. The credit crisis took ten months from then, to really hurt. When is ours coming?


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