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Hurray! My Fund Just Shed Assets!

Investors left in a fund that has witnessed drastic fall in its assets may well get the feeling of being marooned on a sinking ship, but actually, the situation could mean some windfall profits

In recent months, debt funds have witnessed heavy redemptions, owing to the hardening of interest rates and the resultant poor returns. Investors left in a fund that has witnessed drastic fall in its assets may well get the feeling of being marooned on a sinking ship, but actually, the situation could mean some windfall profits.

A number of medium term debt funds have generated unbelievable returns after a substantial dip in their assets. A close look suggests that this is not because of any magical spell of brilliant fund management, but for a more mundane reason. In our previous issue, we wrote about exceptional returns of Prudential ICICI Income Long Term and Libra Bond Fund in the article 'Small Wonders?' This time, we add the name of CanIncome to this growing list of 'small wonders'.

As on May 05, 2005, the fund's one-month returns stood at a whopping 5.05 per cent, taking it to the top of the category. A close look revealed that after March 31, 2005, the fund's NAV was not declared till April 10, 2005 due to the book closure. And the NAV as declared on April 11, 2005 recorded a jump of 4.75 per cent since the last declared NAV. The fund had witnessed a substantial fall in the assets during the month of January 2005, when the assets had fallen to a mere Rs 2.41 crore from the previous month's Rs 122.62 crore.

A very similar thing had happened with the Prudential ICICI Income Long Term and Libra Bond Fund, in both of which a drastic fall in the assets was succeeded by superlative performance. While Pru ICICI says that its Income Long Term fund has been leveraging its small size to trade and generate returns through active management. However, Libra Bond, or rather, the remaining investors of the depleted fund, were blessed with windfall returns as a result of the revaluation of one of the bonds held by the fund. This is what C. M. Mathur, Vice President, Taurus Mutual Fund had to say about it, "We were holding bonds of HUDCO in the Libra Bond Fund. In the fourth week of December, we received heavy redemption requests. In order to create liquidity to meet the redemption, we had to sell the bonds. In terms of SEBI's regulations, these bonds were being valued using Crisil Bond Valuer. However, when we sold these bonds in the market, we were able to get a much better price than the rate at which they were being valued. Due to the fall in unit capital and the increase in profit on sale, there was a sharp increase in the NAV."

The explanation links this valuation of bonds to a well-known principle of accountancy-Principle of Conservatism. Something similar may have happened with CanIncome as well. One can argue that such revaluation should be done at the time of redemption, and the money redeemed to the existing investors should include such excess realizations, since they have a rightful share in this profit.

Whether any practical solution to this is possible or not, and whether any regulatory change will be effected or not, only time will tell. In the meantime, the remaining investors of these funds are not complaining, and their sinking ship has suddenly found wings to fly!

If your debt fund happens to loose assets so drastically, then it might be worthwhile to keep that redemption slip intact for some more time. Who knows, the departing ones might be leaving behind a legacy, and you would be better off taking your share along!