Are Mutual Funds Utilizing the Rs 50,000 Crore Liquidity Window from Banks?

May 22, 2020

Redemption pressure in certain categories of debt mutual funds continued in April due to high volatility and uncertainty the outbreak of pandemic caused. Credit risk funds witnessed highest redemption in the debt category leading to outflows of Rs 19,239 crore during the month.

In a bid to ease some liquidity strain on mutual funds due to the heightened redemptions, RBI opened a special liquidity facility (SLF-MF) worth Rs 50,000 crore for mutual funds on April 27.

Under SLF-MF, RBI conducted repo operation of 90 days tenor at the fixed repo rate. Banks were allowed to avail funds under this facility between April 27, 2020 and May 11, 2020 or up to utilization of the allocated amount, whichever is earlier.

Banks had to utilise the funds availed under this exclusively to meet the liquidity requirements of MFs by:

  1. Extending loans

  2. Undertaking outright purchase of and/or repos against the collateral of investment grade corporate bonds, commercial papers (CPs), debentures, and certificates of Deposit (CDs) held by MFs

The liquidity support under the facility was eligible to be classified as held to maturity (HTM) even if it goes beyond the 25% limit of total investment in the HTM portfolio.

However, RBI's liquidity measure saw low utilisation of just Rs 2,430 crore out of the total Rs 50,000 crore available under the facility.

Some reasons for poor response

As I had mentioned in my article a couple of weeks ago, banks would be reluctant to lend to mutual funds for the following reason:

Many mutual funds investing in credit-risk grade securities have offloaded numerous good quality papers to meet the high redemption and may be now left with high concentration of lower quality papers.

In the current market environment where many firms are witnessing low cashflows and low demand, risk aversion in banks has magnified due to the fear of bad loan pile-up. Hence, banks are not keen to accept lower quality papers as collateral which lacks in liquidity.

On the other hand, mutual funds are looking to limit the borrowings to meet redemptions as it can affect the portfolio returns. Borrowing is always seen as a last resort by mutual funds.

Image Source: photo created by freepik -

In the credit risk funds category, barring Nippon India Credit Risk Fund having negative cash balance of 6%, no other funds have opted for borrowing from bank.

Apart from cash balance in the portfolio, funds are increasingly opting for an inter-scheme transfer of corporate bonds from credit risk funds to other schemes of the same fund house in order to repay investors.

The data from SEBI shows the number of inter scheme transactions during April rose to 829, worth a total value of Rs 21,815 crore from 680 transactions Rs 22,453 in March and 419 transaction worth Rs 15,577 in February.

However, inter-scheme transaction brings with it its own problems. If the security being transferred is of low grade and therefore, less liquid, it would expose the other scheme/s to unwarranted risk. This would be unfair to investors in those schemes and may consequently lead to redemption in that particular scheme as well.

In additions, mutual funds are selling the securities in the open market to meet redemptions. According to media reports, mutual funds are liquidating low rated securities in the market at deep discount due to troubles in the debt market.

Though limiting the borrowings is in the interest of investors, the practices of inter-scheme transfers and selling securities at deep discount debt funds follow to meet redemption raises concern on whether fund houses are keeping in mind preservation of value for its investors.

[Read: Lessons Learnt from the Debt Fund Crisis]

[Also Read: Should Retail Investors Stay Away From Debt Mutual Funds Altogether?]

While redemption pressure in certain categories of debt funds such as short duration, low duration, and ultra-short duration has eased, the credit outlook continues to look bleak.

Therefore, it would be prudent to focus on funds that lay emphasis on quality (even for shorter duration funds) rather than chasing high returns.

Understand the various risks involved before investing in debt funds; some categories of funds such as gilt funds carry low credit risk, but are prone to interest rate fluctuations. Remember that you can manage/mitigate certain risks by holding a well-diversified portfolio.

Preferably, invest in instruments issued by government and public sector enterprises, and stay away from those having high exposure to private issuers.

Choose a fund house that follows a prudent investment process and stringent risk-management system. In these uncertain times, it would be wise to stick to liquid funds and overnight funds for the fixed-income part of your portfolio because they have more liquidity and carry lower risk.

Our friends at Quantum Mutual Fund have highlighted the secret behind their debt management strategy, which has helped them provide safety and liquidity to investors when it comes to investing in quantum funds. Don't Worry, Quantum Liquid Fund always aims for Safety and Liquidity.

PS:  If you wish to select worthy mutual fund schemes, I recommend you to subscribe to PersonalFN's unbiased premium research service, FundSelect.

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If you are serious about investing in a rewarding mutual fund scheme, Subscribe now!


Warm Regards,
Divya Grover
Research Analyst


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