The mutual fund industry, which has suffered due to large exits by institutional investors from liquid funds, particularly in the first seven days, might now heave a sigh of relief.
As from October 19, SEBI has allowed fund houses to impose graded exit load on liquid fund investors who exit the scheme within 7 days from the purchase date.
This means investors redeeming after a day will have to pay more exit load than the investors redeeming it on the seventh day.
SEBI has allowed fund houses to impose an exit load of 0.007 percent on investors if they redeem their investment within a day.
The load reduces to 0.0065 percent on day two; 0.006 percent on day three, 0.0055 percent on day four; 0.005 percent on day five; 0.0045 percent on day six and 0 percent from the seventh day onwards.
For instance, if an investor redeems Rs 1 crore, the applicable exit load will be Rs 700 after the first day, Rs 650 after the second day and so on.
SEBI said the industry body Association of Mutual Funds in India must review the exit load structure on an annual basis.
Generally, banks and companies park surplus cash in liquid funds as they facilitate easy cash management.
Corporates normally park their money in liquid schemes to meet their short-term needs instead of leaving their funds idling in bank current accounts.
The rationale
The move is largely aimed at preventing corporates from using liquid funds to park their money for a very short period.
Large purchases and redemptions from corporates in liquid funds can increase the risk in liquid funds, particularly for retail investors, during times of poor liquidity or credit concerns in the debt market.
Fund managers are of the view that around 30 percent of the money stored under liquid funds is redeemed within the first seven days.
However, SEBI’s move to impose exit load is expected to reduce volatility in the AUM of liquid schemes.
The exit load appears as a deterrent factor. For example: When Rs 10 lakh invested by corporate in liquid funds at 6 percent annual return would mean 60,000 rupees.
This works out to approximately Rs 170 per day over a year, before tax (Return of Rs 60,000 a year before tax divided for daily returns by 365 yields comes to Rs 170).
As per the new load structure, deduct Rs 70 for exit load. So the return would come down to only Rs 100.
A point to note is that corporate funds park funds in multiples of crores. which may enforce an exit load ranging in lakhs.
It is hoped this deterrent would make these large investors park their short instantaneous withdrawal investments to overnight funds.
The overall approach by SEBI is forestalling any redemption run and liquidity crisis threats to liquid funds.
Flashback
In earlier times, at the peak of the global financial crisis of 2008, during the zero liquidity phase of September - December 2008, there was a rush of withdrawals from liquid funds in India. Mutual funds approached SEBI for liquidity support to tide over the situation.
The run on very short term funds especially money market funds happened in the USA in September 2008.US Fund named Reserve Primary Fund which held approx USD 800 million of the go ne bust Lehman Brothers debt papers, faced mass redemption crisis
Investors made redemption requests of $60 billion from the $62 billion dollar fund.
The US Treasury came to the rescue by announcing a temporary guarantee program to protect investors of money market mutual funds.
A similar regulatory support approach to help Indian short term and liquid funds was initiated by SEBI in September-October 2008 in consultation with RBI, quoted a ex-SEBI official who worked in mutual fund department.
A temporary liquidity window for Rs 20,000 crore was opened by RBI for mutual funds to take short term borrowings and pay out the rush of redeeming investors. With the aid of the one-time liquidity window, no Indian scheme collapsed quipped the ex SEBI officer.
As things played out subsequently, the regulator took to multiple actions since then by listing closed debt schemes, imposing the same exit load for retail and institutions, the investment in debt securities in line with scheme durations. This move of graded exit load in liquid funds is yet another system reforming step to ring-fence liquid funds during a crisis period.
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