I think it was Sunil Gavaskar who once made a scathing remark about the England cricket captain Nasser Hussain, "His idea of good captaincy is to put a fielder wherever the batsman hit the last shot." As I have written earlier, the recent liquidity crisis that Indian debt funds faced has led to a tightening of regulations. But are the new regulations just putting fielders where the last shot was hit? Perhaps. Many of the problems that arose in mutual funds during the crisis were the result of questionable practices that should never have been permitted any way. They've been blocked now by new regulations, but the lesson to be learned is much broader than those particular practices.
The crisis had a limited set of causes: there was a severe maturity mismatch between funds' own time horizons and that of their holdings; closed-end funds with illiquid assets actually allowed NAV-based redemptions; redemptions were made at NAVs that were based on theoretical models rather than any market price; investors were given 'indicative' returns that funds would generate. It doesn't take a financial rocket scientist to figure out that these practices were a disaster waiting to happen.
Now, all the loopholes above have been closed. So that's that, is it? Problems were found, their causes have been plugged and now we're cool? Not quite. Those specific problems that caused the last crisis have been fixed, but that's not all. The trick is to figure out where the batsman will hit the next shot.
All the problems that funds faced arose from a certain mindset. They all arose because fund companies stretched obvious safety and risk management standards in order to gain as much business as possible. No one was willing to give a realistic picture to potential investors because then the investor may run away to another AMC. Take this whole concept of 'indicative' yields. Apparently, every salesperson knew that investors were taking it as a guarantee. Orally, people were actually using the word 'guarantee'. Or take the creation of closed-end funds whose holdings were of longer maturity than the fund itself. Or 'liquid' funds that were holding securities of many month maturities.
This gradual stretching of actual practices into riskier and riskier territory seems to be an unavoidable urge that financial services providers get. The entire global financial crisis is a result of this urge. Ideally, these issues should have been detected and shut down by the regulatory process long ago. I don't know why that didn't happen. Perhaps they were defended as 'innovation'. It is crucial that the mutual fund industry avoids these kinds of practices. Sooner or later, it ends badly. The kind of damage that happens to investor interest and confidence inevitably sets things back by years.
Given the realities of operating in a competitive landscape, the regulatory framework should assume that rules will be bent and stretched in undesirable ways. It would be beneficial for investors if the regulator is proactive in making this assumption and in preventing such activity.
The fact that the crisis was resolved doesn't mean anything. The house caught fire and then the fire was put out by some improvised fire-fighting methods. It would have been much better if there had been no fire, or at least if the fire extinguishers had worked.
Ask Value Research 
New episodes every Friday 
New Process Alert 
Seems like you've uploaded a wrong QR code. Please upload the QR code downloaded from MF Central platform.
