Liquid funds : There is no paradigm shift

Liquid funds

Liquid funds : The impact of the revised norms on returns from liquid funds would not be huge.

SEBI, in its board meeting held on March 1, 2019, stated two changes in the valuation of securities in the portfolio of liquid funds, or for that matter any money market or debt fund. One, valuation of securities of residual maturity more than 30 days will be subject to mark-to-market (MTM), which currently is more than 60 days. Secondly, for securities of residual maturity less than 30 days, the valuation basis remains that of amortisation i.e. not subject to MTM. The small change is the difference between the valuation price taken by the AMC and the reference price given by the valuation agencies can be plus/minus 0.025% i.e. 2.5 basis points. Liquid funds

What does not change? The fund categorisation rules, notified in October 2017, remain same as earlier. For example, a liquid fund can have securities of up to 91-day maturity, which remains same. The designated valuation agencies are CRISIL and ICRA, which also does not change. So what changes? Let’s understand how NAV computation happens every day. There is a market-based valuation level given by the valuation agencies, every day, for all securities in the portfolio of mutual funds. This currently is for residual maturity of 60 days or more, which will now become 30 days or more. Currently, securities of residual maturity less than 6o days is

valued on amortization basis i.e. it moves like a straight line, not fluctuating with market movements. This will now be applicable for residual maturity less than 30 days. In case the amortization valuation varies by more than 2.5 basis points than what is given by the agencies, it has to be reset as per the valuation level. Liquid funds

The impact of the revised norms on returns from liquid funds would not be huge. Why? Currently, most liquid funds run portfolio maturity less than two months; only the small component of the portfolio (if any), of more than 60 days maturity will fluctuate with the market. It is likely that now on, AMCs would bring down the portfolio maturity of liquid funds to less than one month, from less than two months

currently. Arguably, with lower maturity, returns may come down. However, this is only a small component in the overall scheme of things. Returns from liquid funds is set to come down any which way. The RBI has reduced the repo rate from 6.5% to 6.25% in February and it is expected that they will reduce rates further. In a situation where we are talking of 50 to 75 basis points of reduction of interest rates, a few basis points due to reduction of maturity is not material. Rather, with relatively lo

wer portfolio maturity, liquid funds will become more stable. Liquid funds

On the other aspect, of amortization, it is not every day that the valuation level will be reset. The purpose of this regulation is, only if the difference with market level is more than the defined range i.e. 2.5 basis points in price terms (not yield terms), it will be reset. Liquid funds

Overall, valuation of all debt and money market securities are guided by the valuation agencies. Subsequent to the volatility since September last year due to default by a large issuer and negative noises about a few other issuers, SEBI has done a fine tuning of the valuation norms for NAV computation. With a lower threshold, 30 days against 60 days, NAVs will move more with market conditions. The advantage will be, in case the fund manager needs to sell the security in the secondary market, the price would not be far from the price assumed for N

AV computation. Returns from liquid funds (or money market funds) will be driven by market conditions and investors need to be just aware of the outcome of the latest SEBI board meeting. Liquid funds

What are Liquid Funds?

Liquid funds are a type of mutual fund that invests in highly liquid instruments like treasury bills, commercial papers, and certificates of deposit. These features make them: Liquid funds

  • Low risk: Due to investments in short-term debt instruments, they offer lower volatility compared to equity funds.
  • High liquidity: Investors can easily redeem their investments typically within a day, providing ready access to cash.
  • Low returns: Since the risk is low, the returns offered by liquid funds are also generally lower than other asset classes like stocks.

Why No Paradigm Shift?

The statement suggests that these core characteristics of liquid funds haven’t changed significantly. They likely remain:

  • A safe haven for parking short-term funds: Investors can utilize them to park idle cash for short periods and earn some returns while maintaining easy access.
  • Suitable for emergency funds: Their liquidity makes them ideal for emergency situations where immediate cash may be needed. Liquid funds

However, some potential changes to consider:

  • Interest Rates: If interest rates rise, returns on liquid funds could potentially increase. Conversely, falling interest rates might lead to lower returns.
  • Alternative Investment Options: New investment options offering similar liquidity and potentially higher returns might emerge. Liquid funds

Overall, liquid funds seem to be positioned as a reliable and low-risk option for managing short-term cash. It’s important to stay updated on any changes in interest rates or new investment options that could affect their relative attractiveness. Liquid funds

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