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Mutual Funds fear Outflows From Liquid Schemes After MTM Order

The Fear of massive outflows from mutual funds (MFs) has started bothering asset management companies after the Securities and Exchange Board of India's (Sebi's) order on short-term debt funds.

Sebi has said that all shortterm debt securities and money market instruments, underlying all liquid and liquid plus schemes of MFs, should be marked to market (MTM).

There is fear that investors may altogether move out from the short-term schemes of MFs and invest in the overnight call money market or the seven-day reverse repo instruments to avoid the risks associated with volatility. Almost 40 per cent assets under management (AUM) of the Rs 7.6-lakh-crore MF industry are in liquid plus schemes. Liquid plus funds gained favour with companies and banks as they generated about 5.5 per cent returns annually while liquid schemes and banks' shortterm fixed deposits got about 4.25 per cent.

With these schemes being marked-to-market, volatility in them is expected to rise and corporates will invest only if they decide to take the additional risk. There is still some time before the guideline comes into effect on July 1. Hopefully, by then, the MF industry will evolve further.

Liquid funds and liquid plus funds are short-term schemes in which large investors, generally companies, park their cash. Liquid plus funds have a longer tenure; while investors can invest in liquid funds for as briefly as a day, the holding period for liquid plus funds is more.

The major difference between the two is in their tax efficiency. Liquid plus funds are more taxefficient than liquid funds. In terms of tax implications, a dividend distribution tax of 28.33 per cent is charged on liquid funds, whereas this rate is 14.16 per cent for liquid plus funds (in case of individual investors) and 22 per cent for companies.

Fund managers would need to be more careful while choosing their portfolio of securities after July 1, 2010. There are occasional periods when volatility is high. Therefore, fund managers will have to identify pockets that are less volatile and bring them into the portfolio.

Sebi has said all short-term debt securities and money market instruments should be marked to market

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