“October. This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August, and February.”
It was thanks to this much touted remark that the Mark Twain Effect was coined. The Mark Twain Effect is the phenomenon of stock returns in October being lower than in other months. After all it was in this month that the infamous stock market crashes of 1927 and 1987 took place.
In India, we have historically had a problem with May. But not any longer. October has taken precedence.
The October Bug
On October 16, 2007, the Net Asset Values (NAVs) of 186 equity diversified funds and 27 tax planning funds touched their 52-week highs. Among the sector-specific funds, this feat was achieved by DSPBR Technology.com and UTI Banking Sector. But in just two days, the market witnessed a steep fall, mainly due to Foreign Institutional Investors (FIIs) pulling out, and some NAVs dropped by as much as 9 per cent in just 48 hours.
It was worse this time. In October 2008, the Sensex retraced its three year level by crashing over 23 per cent in this month alone. The mutual fund industry saw its assets dip by 18 per cent (around Rs 97,000 crore) over this one-month period. It sounds frightening when viewed in isolation. But if looked at in conjunction with the entire market, it really does not appear all that bad considering by how much the market tanked.
Let’s go a step further and dissect where the money went from. The bulk of the assets handled by mutual fund are in debt. Around 30 per cent is in equity and the balance in hybrid and gold funds. What makes the October crisis all the more horrifying is that never before in the history of debt funds have assets crashed so drastically within a month. If it was not for the regulators stepping in — the Securities and Exchange Board of India (SEBI) and the Reserve Bank of India (RBI) — there would have probably been a few fund houses collapsing. The redemptions pressure in debt funds was such that the mutual fund industry as a whole lost more than Rs 58,000 crore, an eye popping 17 per cent of its total debt assets.
What really happened?
The major investors in the debt segment have been corporates who invest their excess cash in short-term debt funds, liquid funds and Fixed Maturity Plans (FMPs) as a part of their treasury management. But the liquidity crisis meant that the companies had to tap their reserves, which consequently led to massive withdrawal of investment.
The normal trend is that in the last month of every quarter the fund houses witness redemptions due to the tax commitments of corporates. What happened in October was that the outflows did not recede even after the outflows in September. The total redemption from the debt schemes in October has been a staggering Rs 3.82 lakh crore. Naturally, the fund houses were drained and had to redeem their portfolios to avoid defaults.
Bigger players like Reliance Mutual Fund and ICICI Prudential Mutual Fund bore the brunt of the redemption pressure. Their combined loss of assets has been more than Rs 15,000 crore. Mirae Asset Mutual Fund and AIG Mutual Fund lost close to 50 per cent of their total assets. Fortis (ex-ABN AMRO) and Mirae Asset introduced restrictions on redemption but later withdrew it. The worst hit debt categories have been the institutional variants of Liquid Plus (lost 35.95 per cent, over Rs 19,000 crore) and Ultra Short Term (lost around 20 per cent, over Rs 12,000 crore). A frightful amount to lose in just one month! Fortunately, investments are still being made.
What about equity?
It was the equity investors who stayed put despite the market value of their investments falling by over 50 per cent. Rather than book profits, they have decided to just sit on the fence. Recently released data by the Association of Mutual Funds (AMFI) states that the equity assets of mutual funds fell by 22.15 per cent or around Rs 36,000 crore. This is in line with the market collapse. Though certain fund houses were worse off than others. JM Financial Mutual Fund and Taurus Mutual Fund each lost over 30 per cent of their equity corpus.
The broader implication of this rapid erosion of the asset base of mutual funds is that fund houses had to sell their debt investments at a loss to honour the claims. But it is the smaller investors who stay invested who are going to face the heat of the massive redemptions. After all, it was purely due to high redemption pressure that Mirae Asset Mutual Fund’s Liquid Plus fund delivered a negative return, which was unprecedented in the history of any liquid or liquid plus fund. For retail investors debt funds provided solace amid the turmoil in the equity markets. Now, investors have nowhere to hide.