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How Sebis new policy fares
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Liquid funds are the largest category of debt mutual funds. Association of Mutual Funds in India (Amfi) data suggests that this category of debt funds has seen largest growth this financial year, where every other category of debt funds has shown de-growth. And that’s not surprising, considering that the first half of FY19 saw liquidity tighten significantly, as currency with the public grew beyond the levels that existed prior to demonetisation and RBI had to step in to stem the volatility in the rupee in the foreign exchange market.

With both phenomena hitting the system simultaneously, debt markets naturally reacted negatively with yields rising across the curve. RBI responded by raising rates by 25 bps each, in June and August 2018. It was natural for debt investors to take a conservative view on rates and move allocations to the liquid category from the income categories. Liquid funds, by regulation, can only invest in securities maturing within the next 91 days.

While upside to returns is palatable to investors, the downside risk needs investors’ attention. The natural response from a portfolio manager’s perspective would be to reduce portfolio maturity. But this is easier said than done. Issuances in money markets are largely driven by the issuers’ liquidity and ALM requirements . In fact, issuers would be willing to offer better rates for their choice of maturity in a tight liquidity environment rather than exposing themselves to the vagaries of the market more frequently. This phenomenon is not new. Hence, from a markets perspective, the yield curve may actually steepen.

Fortunately, another category of debt funds has gained popularity: overnight funds. These funds invest only in overnight instruments and so has the least interest rate risk. Short term investors who are apprehensive about volatility in daily returns can park their money in such funds, even though YTM of such funds in lower than liquid funds. In summary, Sebi’s decision is a leap in the right direction and will build investor confidence in the industry. The last time the liquid category witnessed a major regulatory change was in the aftermath of the global financial crisis over a decade ago. We have seen the category grow, as investors and portfolio managers alike adjusted to the new regime. One is confident history will repeat itself.

Source : Live Mint back

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