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July 25, 2019

Reduced maturity to help balance returns and volatility

Liquid funds, armed with nearly Rs 4 lakh crore of assets as of June 2019, have proved to be the largest debt mutual fund category in the country, thanks to stable returns.


Their stable performance is attributable to the Securities and Exchange Board of India’s (SEBI) valuation guidelines, which allowed mutual funds to amortise investments in securities of less than 60-day maturity, thus reducing the volatility that typically emanates from mark-to-market (MTM) valuations.


However, last month the market regulator changed the very criterion that drew investors to liquid funds. It reduced the threshold for amortisation to 30-day maturity on June 22, 2019, and then announced in the last week of June proposal to move to full MTM. This means, all debt securities in a liquid fund’s portfolio would now have to be valued at their market price. In addition to the reduction in threshold, SEBI has modified the amortisation rule to 0.025% of the reference, compared with 0.10% earlier, to bring the reset price closer to the market price.


Impact analysis


Given the institutional investors’ preference for capital protection and stable returns, funds will typically look to bring down the average maturity profile. To analyse the level of decrease in maturity profile that would be needed, CRISIL analysed various asset allocation scenarios between holding of securities with maturity less than 30 days and more than that, and compared it with current returns offered by the category.


Our analysis shows that share of less than 30 day maturity securities to more than 30 days maturity in a ratio of 60:40 is expected to provide similar volatility and returns as that provided currently by the category across the investment horizon spectrum. We believe this is the ideal portfolio composition because fund managers will be able to maintain equilibrium in returns and volatility.