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Fixed Income

Liquid Funds NAVs Fall for the First Time in 5 Years

Liquid Fund Investors have taken it on the chin with the fall in bond prices yesterday. Across the spectrum, for the first time since 2008, Liquid Funds have fallen around 0.2% on July 16, which is an annualized fall of….wait, let’s not get stupid and try to annualize a one day fall in bonds. Here’s the list:

Fund Jul-16 Jul-15 Change
ING Liquid Fund 24.6638 24.7486 -0.34%
Quantum Liquid Fund 16.9308 16.9781 -0.28%
DWS Insta Cash Plus Fund 19.7611 19.8131 -0.26%
L&T Liquid Fund  1644.7143 1649.0143 -0.26%
Kotak Liquid 2260.2502 2266.0098 -0.25%
Principal Cash Management Fund  1165.4774 1168.4451 -0.25%
Reliance Liquid Fund-Treasury Plan 2921.1051 2928.1634 -0.24%
Birla Sun Life Cash Plus  192.1657 192.6104 -0.23%
JPMorgan India Liquid Fund 14.2036 14.2363 -0.23%
HDFC Cash Management Fund  25.0565 25.1135 -0.23%
Religare Invesco Liquid Fund 1648.9476 1652.6882 -0.23%
Sundaram Money Fund  25.2935 25.3473 -0.21%
Baroda Pioneer Liquid Fund 1374.7201 1377.6247 -0.21%
Taurus Liquid Fund 1558.4587 1561.726 -0.21%
DSP BlackRock Liquidity Fund 28.3021 28.3608 -0.21%
IDBI Liquid Fund 1287.0052 1289.6532 -0.21%
UTI-  Liquid Fund-Cash Plan 1903.0043 1906.8792 -0.20%
Axis Liquid Fund  1329.2837 1331.8348 -0.19%
Tata Liquid Fund Plan A 2215.0341 2219.1199 -0.18%
Pramerica Liquid Fund  999.6694 1001.4746 -0.18%
Birla Sun Life Floating Rate 159.4547 159.7396 -0.18%
JM High Liquidity Fund 32.7098 32.7679 -0.18%
Canara Robeco Liquid-Regular Plan 1458.4159 1460.997 -0.18%
SBI Premier Liquid Fund 1886.0524 1889.2991 -0.17%
ICICI Prudential Liquid  177.5085 177.7998 -0.16%
IDFC  Cash Fund  1458.8483 1461.2355 -0.16%
LIC NOMURA MF Liquid Fund 2174.9464 2178.4663 -0.16%
HDFC Liquid Fund 23.6685 23.7067 -0.16%
BOI AXA Liquid Fund- Regular Plan 1380.3935 1382.5764 -0.16%
Edelweiss Liquid  1183.8301 1185.6322 -0.15%
MS Liquid Fund  1178.8718 1180.6085 -0.15%
BNP Paribas Overnight Fund 18.4607 18.4872 -0.14%
Peerless Liquid Fund 12.5597 12.5759 -0.13%
Templeton India Cash Management Account 19.4132 19.4379 -0.13%
ICICI Prudential Money Market Fund 166.1902 166.3933 -0.12%
Daiwa Liquid Fund  1340.0904 1340.9971 -0.07%
Escorts Liquid Plan 18.5786 18.575 0.02%
Mirae Asset Liquid Fund 1223.7909 1223.5215 0.02%
HSBC Cash Fund  11.4467 11.4248 0.19%

Even a 0.2% fall is large enough to spook investors. Liquid funds are typically funds where you expect the NAV will go up every day, as long as the bonds that the MF has bought don’t default. And in general, rules allow mutual funds to “straight line” the NAV. Example:

  • I buy a Government Treasury-Bill with 30 days left to maturity, at Rs. 99.70.
  • Tomorrow, because of some drama in the market, the price falls to Rs. 99.60
  • I have made a “mark-to-market” loss of Rs. 0.10 – which should reflect in my portfolio
  • However, the T-Bill will give me Rs. 100 in the last 29 days, and the government backs it, so there is little risk of default
  • In such a case, I am allowed to mark the bill using the straight line method – From 99.70 to 100 in 30 days, or Rs. +0.01 every day. So I’ll say the next day the price is Rs. 99.71.

This is okay in a one-off case. But what if, when the price falls, half my investors redeem their money? I will know of redemptions only after market hours, so what should my NAV really be?

If I have to sell in the market at Rs. 99.60, but if I tell investors that the price is 99.71, the differential is a Rs. 0.11 that doesn’t exist.

Earlier, like Dheeraj writes, there was a “promoter put” in place – an implicit assumption that in such cases, the promoter of the mutual fund would take the hit and not allow investors to see losses. The promoter may buy a distressed security at the higher price and take it on his own books, like it happened when Deccan Chronicle defaulted on paying back a few mutual funds.

This is effectively the promoter underwriting your losses – a “put” option given to you for free. But obviously in a system-wide fall in prices, it will be impossible for any mutual fund promoter to take the hit.

Yesterday was one such case. Prices of nearly all securities fell. And it seems redemptions were a massive number, with many entities hoping that the “promoter put” will save them from action. However, it looks like Mutual Funds decided, all together, that they can’t have this happen – and so, all funds were marked down to the market.

Liquid fund investors will be spooked – after all you never really worry about loss of principal in what is supposed to be a safe investment, and here you’re losing 0.2%. But this spookiness is the correct thing – all investors need to understand that at the edge, there is risk. If liquid fund investors can stick around a little longer, they are likely to see a recovery (if the funds don’t have to sell the underlying investments, which will converge to par in a short while). But when patience does not exist, the hit has to be taken.

Take the largest Liquid Fund, ICICI Prudential Liquid plan (nearly 20,000 cr. in assets) and how it’s NAV has been hit.

ICICI Prudential Liquid Plan NAV: Capital Mind

As you can see, things have fallen only a little bit – we’re back to about the levels of about 10 days ago. Put another way, it might be prudent to stick around a few days longer and not panic-redeem the fund.

If yields fall further – short term yields are now at 9.5% – these funds might just be a great place to put additional money into.

To help redemptions go through smoothly, RBI has allowed banks to borrow in a special repo window (temporary) at the higher 10.25% rate to lend to mutual funds (who can give the underlying collateral as security instead of selling it). Given that funds have marked their positions to market, they might not need such a facility, but it’s useful to have it, even if the rate is 10.25%.

Two clear takeaways:

  • Don’t panic, things aren’t quite as bad as they seem, such funds will rebound.
  • If short term yields go up further, you might get a great deal if you put in additional money.

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