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Liquid Funds Suffer Severe Fallout from Economic Crisis

In July alone, investors pulled out a humongous Rs 45,296 crore from liquid funds revoking their trust in the category

Somewhat unexpectedly, liquid funds turned out to be one of the parts of the financial system that suffered severe collateral damage from the Reserve Bank’s blundering and unsuccessful attempts to defend the rupee. Normally, liquid funds are the most quiet and uneventful part of the mutual fund universe. Returns are utterly predictable and, as a result of rigid portfolio norms put in place by SEBI after the 2008 crisis, there’s little that should surprise either the investor, or indeed, even the fund managers themselves. The typical investor is a corporate using these funds as a place to park short-term surplus cash. This is a job which liquid funds do better than bank deposits, offering more flexibility and higher post-tax returns.

However, all this has turned topsy-turvy since 16th July. That was the day when the RBI tightened liquidity while trying to keep systemic interest rates unchanged. Bond yields shot up wildly and even very short-term bonds--which is what liquid funds keep in their portfolios--dropped in value. This was entirely unexpected and most liquid funds made losses that day for the first time in living memory. That day, liquid fund NAVs dropped in the range of 0.07 per cent to 0.38 per cent.

Investors have reacted by wholeheartedly revoking the trust they once had in these funds. In July, they pulled out a humongous Rs 45,296 crore from these funds. This is as much as 28 per cent of what their assets under management (AUM) were in the beginning of July. AUM has dropped from Rs 1,62,390 crore in June to Rs 1,29,000 crore in July. Although Rs 44,300 crore was pulled out in June too, that was normal and expected. Quarter-end months like June always see large withdrawal as corporates need cash for advance tax and other periodic requirements. It’s the July withdrawal that has shocked the fund industry, being by far highest-ever withdrawal in a non-quarter end month. The next highest is a paltry Rs 450 crores (4.5 per cent of AUM) that happened twelve years ago in July 2002.

What does this mean? Are liquid funds irretrievably damaged as a category? Probably not, as a bulk of the money is still invested in them. However, with the economic crisis continuing, bond yields still rising and the authorities thinking up strange new monetary tricks almost on a daily basis, there’s no telling when normalcy will return.