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Open-ended income funds may see NAVs dip
Aabhas Pandya
In one blow, the Reserve Bank of India has taken the sheen off open-end income funds, which have been caught unawares. The impact, however, will be only in the short-term as higher interest rates would now give funds an opportunity to invest the mobilised moolah in better yielding securities. The measures will only add to the fall in prices of debt instruments after Peregrine reportedly liquidated holdings of its 200 million debt fund last week.While LIC Dhanvarsha (11), which is currently open for susbscription, may not revise the assured return, it will now lock-in the mobilised amount in better yielding debt instruments and thus pay a higher than assured return to its investors. ``We cannot pay lower than assured returns but there is no stopping us from declaring higher returns because the benefit must be passed on to the investor,'' said an LIC MF official. However, sources in LICMF concede that the target of Rs 150 crore for Dhanvarsha (11) may not be attained now. ``If investors understand that the
rise in interest rates would help us give them higher returns than those promised in Dhanvarsha (11), they would definitely come to us,'' a source said. It remains to be seen whether UTI would postpone the launch of MIP '98 and revise the assured returns. On the other hand, funds like Reliance Bond Fund and JM Debt Fund are likely to benefit since they tapped the market only towards the end of December and may not have deployed the entire initial susbscription amount. This is also likely to hold true for UTI's Institutional Fund which mobilised close to Rs 600 crore in December, 1997. For the informed investor, it makes sense to exit at the current NAV and enter at a later date when the NAV has fallen and settled at a particular level. Of course, the extent of fall would vary from fund to fund, depending on a host of factors including portfolio diversification and the percentage of portfolio which is marked to market. The first casualty of RBI measures has been Cholamandalam's Chola Freedom, where net
asset value took a beating on Friday itself. While the NAV of the growth option fell from Rs 11.91 to Rs 11.81, that of income option nosedived by 9 paise to settle at Rs 11.10. This is just one instance of drop in NAV and more income funds, especially open-end are likely to follow suit this week. While closed-end income funds are insulated from any panic among investors, it is the open-end schemes, especially smaller ones like Chola that run the risk of facing redemptions. As a fund manager points out, ``The Indian pysche is such that investors do not want even a single paise drop in the NAV but any panic will be unfortunate.'' The drop in a fund's NAV would critically depend on the percentage of portfolio which is `mark to market'. Thus, smaller funds are more vulnerable since they manage to invest almost 100 per cent of their corpus in traded debt securities. With an across-the-board fall in prices of securities, the NAVs of such funds will be the first to hit. For instance, funds with a corpus of Rs
10-12 crore are normally invested in 8-10 highly liquid debt instruments and the fall in market price of even a single debt instrument knocks down the NAV. ``Based on their liquid and high-coupon portfolio, these funds had witnessed a fantastic appreciation in NAV when the interest rates started declining. With a lower mark to market, they registered hefty gains with a rise in prices of debt instruments. However, now with a rise in interest rates, they would have to rush to adjust their mark to market and thus, show a depreciation on their value of investments,'' elaborates an analyst. For instance, Chola Freedom's gain in NAV is partly on account of capital appreciation of underlying debt instruments and partly due to accrued interest income. For funds like Birla Income Plus, DSP Merrill Lynch and Alliance Liquid, the measures may not pose much of a problem since their huge corpus has provided them adequate diversification, with 50-60 debt instruments on an average. Besides, funds which currently have a
high cash equivalent will benefit immensely since they can pick up securities at a lower price or better yield. On the other hand, in the event of any redemption pressure, the request can be entertained from cash holdings and not by liquidating a part of their traded portfolio. In the past, income funds like Birla Income Plus, DSP Merrill Lynch, etc have seen their corpus swell on account of high returns. However, in a falling interest rate scenario, deployment has been a problem with income funds attracting fresh inflows. As a result, there has been an appreciable decline in the growth of NAV on month-to-month basis. Now with interest rates expected to firm up by at least 150 basis points, these funds are likely to witness a faster growth in NAVs over the medium term.
Copyright © 1998 Indian Express Newspapers (Bombay) Ltd.
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