Franklin Templeton recently shut down six of its debt fund schemes, after redemptions had started to overwhelm the managers. This has shaken the entire industry badly, and investors are now running to safeguard their funds.
Mutual fund managers have done their best to save the industry from a liquidity squeeze. Now, the RBI is providing a 50,000 crores liquidity window through the Targeted Long Term Repo Operations. At least for now, things appear to be calm.
This redemption pressure is the second one in less than two years, with the first one having occurred after the Infrastructure Leasing & Financial Services defaulted on payments.
What is at the heart of all these troubles?
Debt mutual funds want to be like a bank for investors, wherein investors can get money at the click of a mouse, but without similar robust liquidity back up.
Offering MF units that are repayable on demand where the NAV is passed through to the investor is the same as offering deposits that are repayable on demand in banks, but without the cushioning of high-quality liquid assets, therefore amounting to significant regulatory advantage.
Two factors work against the model. One is information asymmetry, wherein smart and wealthy individuals who have advisors bolt at the first signs of trouble. The second is a lack of saleable assets to be able to raise liquidity.
Why are the dice now loaded against retail investors?
More than 90 percent of the aggregate AUM of debt funds is made up of corporate and other high net individuals. While regulators are looking at segregating retail, the institutional and wealthy money ensures that the situations do not leave the common man even poorer.
At the same time, it is also in the industry’s interest that debt MFs hold greater government bonds so that they can remain liquid and meet redemptions.
According to the RBI paper, considering the issues of incentive compatibility via bail-out mechanisms as well as the attendant moral hazard issues that are brought in by size, there is a clear need to balance out the growth in AUM with that of additional liquidity buffers. This will help to moderate risk and spillovers. One way to address the same is through stipulating that as the size of a debt scheme increases, the ratio of government securities in incremental holding should increase too.
Thus, while holding a sovereign paper will depress the overall returns in a corporate bond portfolio, it can be a cushioning against going with humility in times of stress.