Debt valuation rules to hit short-term funds

RELATED NEWS SEBI revises valuation of debt securities held by MFs

India's move to force mutual funds to mark debt holdings to daily market levels will add to volatility and may push investors out of a market that is a popular venue for banks and companies to park excess cash.

Short-term bond funds that will be most affected by the clampdown, which takes effect July 1, managed Rs 2.8 trillion (USD 61 billion) of the Rs 7 trillion Indian funds industry at the end of December, data from fund tracker ICRA Online showed.

On Wednesday, bankers said they had temporarily stopped issuing short-term debt maturing later than September as demand had all but dried up. None wanted to be identified.

Two companies, including top mortgage lender Housing Development Finance Corp, on Wednesday raised a total Rs 8 billion via short-term debt due in September, locking in low rates for the longest possible duration before the paper would be subject to the new rules.

Only one other commercial paper issue had been made this year, and all the investors in both issues on Wednesday were mutual funds, according to Thomson Reuters data.

"Right now, all issuers are in the up-to-September bracket as the investors want to ensure that as at July 1 the paper they hold does not have a balance maturity of more than 90 days," said a senior official at HDFC who was not allowed to speak to media.

Continuing its crackdown on debt mutual funds following a liquidity crisis in the second half of 2008, the Securities and Exchange Board of India (SEBI) late on Tuesday directed mutual funds to mark-to-market short-term debt with a residual maturity of up to 91 days.

The move was expected but timing and details were not known.

"The cover of not having to mark-to-market and therefore insulating it from the market volatility will go," said Mahhendra Jajoo, head of fixed income at Tata Asset Management. "There is a lot more possibility of negative returns in any of these schemes, so people will have to be much more careful," he added.

The move, which follows the central bank's expression of concern last month over cross-investments between banks and funds, may drive up short-term borrowing rates.

Credit cycle

After loan growth dried up during the global downturn, Indian banks would park surplus cash in ultra short-term funds as they offer high liquidity and returns that topped money markets.

Short-term debt funds that maintain average portfolio maturities of over 91 days but less than one year have yielded a 2.39% return in the last three months, according to data from fund research firm Morningstar.

According to central bank data, Indian banks' investments in mutual funds of all types soared to Rs 1.03 trillion as on Jan. 15, 2010, versus Rs 450 billion as on Jan. 2, 2009.

This in turn sparked heavy short-term debt issuances from banks and companies, leading to the central bank cautioning that these cross-investments led to significant rollover risks and concerns in case of mass redemptions.

The assets in short-term debt funds are volatile, with billions of rupees flowing in and out of such funds each quarter.

One such surge, when cash-starved corporates pulled out more than Rs 900 billion from debt funds, contributed to a liquidity crisis in Sept-Oct 2008, forcing the central bank to offer money through a special money market operation.

This also led to unexpected negative one-day returns from money market or ultra short-term funds run by Mirae Asset, Franklin Templeton, DSP BlackRock and Kotak in October 2008.

The new requirement, which comes as interest rates are set to rise, will erode the net asset value (NAV) of short-term bond funds and detract from their allure, said Vivek Mhatre, deputy general manager, treasury, at Union Bank of India.

"Essentially, SEBI wanted to preserve the liquid nature of the schemes and protect them from mismatches or pressure in case of redemptions," he said.

However, he added that an expected pick-up in credit offtake would anyway dampen the appeal of such schemes, as banks would prefer lending the money to borrowers at higher rates.

Indian bank loans rose 13.9% from a year earlier as of January 15 after dipping to 9.7% in November.

"There will definitely be an aversion towards buying longer-tenure CDs (certificates of deposit) and CPs (commercial paper), but I don't think there will be a sharp movement in yields as investors had already turned cautious in this regard a couple of months ago," said Bekxy Kuriakose, head of fixed income at DBS Cholamandalam Asset Management.