Wednesday, October 28, 2009

Shaking the apple tree- The unsafe Liquid Funds

An interesting article on money market mutual funds :

In India, the name given is 'Liquid' funds. Here we have instances of some funds in the past that have broken the buck ( given negative returns on one or more days) and yet continue in business.
In the Liquid funds, more than 90% of the Assets belong to corporate investors including banks. Often, banks borrow in call money and invest in the mutual funds to arbitrage. This kind of an industry structure is fragile. I know of corporates who invest in Liquid Funds for tax arbitrage. The dividend receipts are tax free.
The net result is that since the corproate sector provides the bulk of the corpus, the mutual fund industry has totally neglected the retail (let us call it non-corporate) segment.
The only way the industry will get its focus right is if the government stops corporates and banks from investing in mutual funds. This can be done either by executive fiat (Only resident / non- resident indian individuals can invest in domestic mutual funds) or by tax legislations ( investment income of any kind for corporates will be treated as 'speculative' income).
Towards 2008 middle to end, a lot of mutual funds held "commercial papers" of real estate companies, which were in reality 'illiquid'. Most of them were 'rolled' over ( a ponzi evergreening scheme if ever) or sold to a group company before due date. There were defaults and liquid fund redemptions were an issue. Regulators and investors have conveniently forgotten it.
The worst are the banks that invest in Mutual Funds. Firstly they run out of risk limits on many companies to whom they lend beyond reason. often, the money they invest in the mutual funds is used to lend to these companies! So, in effect, they circumvent all legislation and regulations.
Like everything else in India (especially where you have a dumb regulator like RBI), change will be forced only by a catastrophe.

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