The closure of six debt funds of Franklin Templeton poses risk to not only people who invested in it but also to other unrelated investors. A financial system has complex inter linkages among various firms and often failure of one important player can have far wider ramifications. Failure of any institution raises fears in other investors and can dampen the market sentiment, turning into a contagion.
In order to address this risk, the Reserve Bank of India announced a special package for Rs 50,000 crore for mutual funds that have been facing heavy redemption pressures not only from individuals but also from institutional investors.
Will it address fears of contagion?
Besides lending against securities held by MFs, banks have been allowed by the RBI to do outright purchase of more than 25 per cent of Hold Till Maturity (HTM) securities in mutual funds portfolios in the absence of liquidity in the secondary market. So, if mutual funds face lack of liquidity in the secondary market for investment grade securities, they can sell these holdings.
With the timely intervention by the central bank, the scale of the problem appears quite small at this stage. Only a few players faced alarmingly high levels of redemption pressure and went for borrowing to meet the redemption pressure. Nilesh Shah, Chairman, AMFI says, "Barring four fund houses who have collectively taken loan of Rs 4,427.68 crore, as on April 23, 2020, which is a small percentage of the RBI announcement and also overall MF Industry AUMs, none of the other 40 Mutual Fund houses have any borrowings, thereby indicating sound liquidity."
Ashish Shanker, Head of Investments, Motilal Oswal Private Wealth Management agrees. "There is enough liquidity in the market for a good quality paper. However, it was important for the RBI to issue this communication and support to calm nerves. This should address the panic caused over the weekend over the Franklin news. Even in 2008 when this measure was introduced, none of the MFs actually utilised it. So this is more of a backstop."
However, this facility cannot guarantee liquidity against low rated securities. The notification from the RBI says, "Funds availed under the SLF (Special Liquidity Facility)-MF shall be used by banks exclusively for meeting the liquidity requirements of MFs by (1) extending loans, and (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 players which have a higher percentage of low rated debt securities in their portfolio may still face difficulty. Industry players say it will be interesting to see if banks will lend against high risk debt papers through this special facility. "Mutual funds have ample AAA-rated exposures which can be used for this purpose. But, it will be interesting to see if banks are willing to lend lower down the credit curve, should it come to that," says Morningstar India.
This move by the RBI is expected to allay investors' concerns as it gives confidence to stakeholders that RBI is willing to go the extra mile to manage the crisis. Previous occasions when such a window was opened were in 2008 and 2013, but it was hardly used by the MFs and banks because of the improvement in sentiments. While the central bank's move and intent is likely to arrest the contagion for the time being, the future direction of the market will depend upon the persistence or reduction of the redemption pressure.
What should you do?
Although the RBI's confidence-building measures will assuage investors' concerns, they should still consider reviewing their portfolios to switch to quality debt schemes.
"The announcement provides a sigh of relief to the debt fund investors who were panicking and planning to withdraw their investments. Although, as an investor you should still be cautious while staking your money with asset management companies and make sure to choose only those AMCs which possess more quality debt instruments (AAA-rated) in their portfolio," suggests Pranjal Kamra, CEO, Finology.
Deepak Jasani, Head Of Research, HDFC Securities says while RBI's special package will stabilise sentiments across debt and equity markets at least for a few days or weeks, it will do little to halt the NAV hit due to possible downgrade of papers held by mutual funds amid sluggish economic activity emanating from the pandemic.
"Going by the way the corporate health could deteriorate due to the pandemic, there is some probability that RBI might have to step in again after a few weeks. Meanwhile investors in debt mutual funds will do well to review investment by the schemes in which they have invested and in case they feel the need, shift to safer (even if they yield lesser) categories of mutual fund schemes or in extreme cases other safer instruments including bank FD (subject to limit of Rs.5 lakhs per Bank) or govt savings schemes," adds Jasani.
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