regulations, an MF scheme is allowed to borrow up to 20 per cent of its net assets for six months. This provision comes in handy in times of liquidity stress, as seen last month. In March, the debt segment saw gross redemptions of Rs 14 trillion, and net outflows were the highest-ever at Rs 1.94 trillion.
Many schemes had to resort to heavy borrowing to honour these requests, aggravated by record selling by overseas investors and redemption pressure from corporate treasuries.
At the end of March, nearly a dozen schemes were approaching the 20 per cent threshold and some had even crossed it. This prompted industry players to formally approach the regulator to raise the borrowing limit to tide over the unprecedented crisis.
“The regulator is closely watching the situation. It is cognisant of the fact that MFs are in a Catch-22 situation, as on the one hand they have to meet redemptions, and on the other hand, they are unable to easily liquidate their bond holdings as the market is under virtual freeze,” said a source, adding that schemes that had crossed the limit were being examined by Sebi.
Dhirendra Kumar, chief executive officer of MF tracker Value Research, said such borrowing to manage liquidity came with a cost and MFs should use it wisely.
“Whatever is the new cap, it is the trustees’ responsibility to decide at what point to close the gate. Every offer document has a force-majeure kind of clause to stop redemptions. However, it is better to use the borrowing provision wisely,” he said.
Typically, corporate and institutional investors
redeem investments to shore up balance sheets at the end of every quarter. These funds are deployed back in debt schemes, which helps normalise the situation. However, this time around, industry players fear bulk of the flows may take time to come back as corporates continue to face cash shortages due to the extension of the nationwide lockdown, imposed to contain the outbreak of Covid-19.
“In the event that flows don’t come back, liquidity management will be critical. Overdraft levels are close to limits, according to March-end portfolios, for many schemes. This may lead to higher impact costs if further redemptions are seen,” said Jiju Vidyadharan, senior director, Crisil Funds & Fixed Income Research.
If MFs have to resort to more borrowing to meet redemptions, it will weigh on the scheme performance.
“Borrowing costs need to be adjusted in the schemes’ net asset values. At the same time, some amount of borrowing can help existing investors as the selling of securities to pay exiting investors can lead to mark-to-market impact in an illiquid market,” said senior executive of a fund house.
Redemptions are on the higher side as several corporates are finding it difficult to generate cash flows from their operations due to the lockdown, he added.
Besides availing of the borrowing facility, MFs have the option to use the repo market. “Corporate bond repo was another option before MFs. However, the repo market has not really taken off in India yet,” said Vidyadharan.