MFs up derivatives exposure to hedge against uncertainty in equity markets

Mutual funds (MFs) have bought a large chunk of derivatives to hedge against the increasing uncertainty in equity markets. The data with the Securities and Exchange Board of India (Sebi) shows that MFs bought Rs 228 billion worth of equity derivatives in August. At 2.2 per cent of MFs’ equity assets, the share of equity derivatives was the highest in more than three-and-a-half years. The last 12-month average stood at 1.35 per cent.

“The rise in derivatives exposure is on account of the sharp spike in market volatility. Uncertainty in the markets has gone up due to the ongoing currency risks and trade wars. So, fund managers are hedging against these risks,” said Rajesh Iyer, chief executive officer of DHFL Pramerica MF.

Experts say mutual fund exposure to derivatives would only rise as markets enter an uncertain phase ahead of the election season.

Recently, markets have seen sharp swings as default by IL&FS - an entity partly owned by state-owned companies - has cast doubts on credit quality of other financial companies. This has resulted in liquidity drying up even for debt papers with high credit ratings; raising concerns on these companies’ ability to raise debt at comfortable borrowing costs.  

Weak economic conditions have also hurt the sentiment in markets. The fall in rupee and rise in price of crude oil - India’s top import item - has stoked concerns of inflationary pressures. The rupee has slipped over 10 per cent in FY19, while crude prices have surged 18 per cent in the same period.

The BSE benchmark Sensex has corrected nearly six per cent in September - its worst monthly showing since February 2016.

The financial space which is usually a preferred choice for investments by fund managers has been among the worst hit. The BSE Finance has corrected 13 per cent, with the likes of housing finance companies such as Indiabulls Housing, Can Fin Homes and Dewan Housing Finance losing 25-56 per cent in September.

MFs are not only increasingly hedging their risks, but also slowing down their investments in the stock markets. The mutual funds flow of investments in this fiscal year has slowed down to a monthly average of Rs 122 billion, which is 23 per cent lower than last nine-months' average of Rs 159 billion.

To arrest the fall in rupee and deal with the liquidity squeeze, the government on Wednesday raised import taxes on $12 billion worth of goods to narrow the current-account deficit (CAD) which has touched a four-quarter high.

On Thursday, the central bank Reserve Bank of India (RBI) also stepped in as it allowed the banks to dip further into the statutory liquidity reserves to help them meet their liquidity coverage ratio needs.  However, the investor confidence in the market continues to remain fragile, say experts.

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