ARE WE TAKEN FOR A RIDE

Pushed to the wall, several mutual fund (MF) houses have cut off-market deals with corporates and financial institutions to fight the cash crunch.

With redemption pressures mounting amid a liquidity squeeze, some fund houses have given “guaranteed” returns to big-ticket investors who were willing to bail them out by parking money in MF schemes for a few weeks. Under the arrangement, even if the net asset value (NAV) of the scheme dipped, these investors would be allowed to exit at a higher, pre-agreed NAV — something that other investors in the scheme would be clueless about.

This is just a variant of a mutual fund industry practice, where big investors are given cash incentives upfront to invest, as fund houses try to outwit each other in the numbers game. However, this time, the ‘extra’ return is handed over to the investor at the point of exit; and the intention is not to grow the fund’s assets under management, but to avert a serious crisis, or even a default.

As inflows dried up and the prices of securities plunged, several MFs found it difficult to meet redemptions, with investors pulling out money from fixed maturity and liquid funds. The deal with corporates was a sharp practice in desperate times.

This is how it works: say, the NAV of a scheme is Rs 10.10 when the corporate invests in it; the deal is that the money will lie with the fund for a fortnight, after which the corporate will exit at an NAV of 10.25. Even if the NAV slips to 10.05 after a fortnight, the investor still gets out at 10.25. The fund finds a way to pay this extra 20 paise (per unit) to the investor.

“Either the asset management company pays the extra return, or it can be shown as marketing expenses... However, some funds have charged this as expense in an existing scheme, where expenses can be amortised over the life of the scheme. It’s virtually impossible for investors and even auditors to get wind of this,” said an industry source familiar with such transactions.

The extra return could be handed over as an incentive to MF distributors who pass it on to clients. “At times, the investor collects the extra guaranteed money through a separate cheque, which is credited to the account of one of its investment subsidiaries. So, in its book, the investor may show that it has exited at the market NAV (i.e., Rs 10.05) just like any other retail investor, while he collects the extra money in a group subsidiary,” said a senior distributor.

There are fears that more fund houses will have to resort to such transactions if redemption pressures continue. Last week, the Reserve Bank of India used every monetary policy tool in the book to flood the market with liquidity. A slice of it may eventually trickle down to mutual funds. But it won’t be instant or easy.

RBI recently opened a liquidity window where banks can borrow from it and onlend to MFs. But not many mutual funds will benefit from this. First, such loan lines are expensive, costing MFs an interest rate of 12-13%; and second, few funds actually hold adequate certificates of deposits (CDs) — the instrument against which loans are available under the special window.

What has actually compounded the problem is the bag of illiquid securities that the fund houses are holding. This pile of papers of around Rs 40,000-45,000 crore, for which there are no takers, is possibly the toxic assets in the Indian financial market. It comprises pass-through certificates (PTCs) — securitised instruments against consumer durable and other loans, debentures floated by real estate companies and similar securities issued by non-banking finance companies. MFs can’t sell these papers, and have been forced to off-load good and more liquid investments like CDs.

One of the funds had to sell back some of the PTCs it was holding to the issuer of the instrument. PTCs are like bonds, and in this case, the PTC which had a coupon of 12% was sold back to the issuer — a Mumbai-based NBFC belonging to a large corporate — at 18%. It’s a situation where the lender of money requests the borrower to prepay the amount at a considerable discount.

According to a money market trader, it’s difficult for MFs to return to their earlier position, unless commercial banks resume investing in liquid funds — something that could take time. Besides, any upswing in the market could actually trigger fresh redemption pressures, since investors who find themselves currently trapped would try to exit. As things stand, mutual funds will have to continue firefighting till they find a way to get cheap money or get rid of their dud investments.
Economic Times----

MARKET CRASHES ARE YOUR FRIENDS

In the equity markets, one makes more money not despite the crashes but because of the crashes. Let us see how with an assunmption that post-tech crash of 2000-2001 never happened the way that crash actually happened. The Sensex reached a peak of about 5900 in Feb.2000. It then crahed and went as low as 2600 in Sept. 2001. It started rising and reached the previous peak of 6190 again only in Jan.2004.
Let`s assume that the crash never happened. The sensex reached 5600 in March 2000 and then stayed at that level till Oct. 2004. If that happened, then an investment of say Rs. 20000 a month in Sensex based index fund in early 1997 would be 55 lakh at 14% till today instead of 66 Lakh. that is right. for the long term investor, the crash of 2000 was worth a lot of money.
How did you make more money because of the market crash? The answer is obvious who understands the basic arithmetic of what is happening here. The crash unabled you to buy cheap and thus eventually raised your total returns. If you are steadily investing for the long term, then intermttent crashes help you make more money, not less.
And this is how you will make profit eventually from this great panic of 2008. THe longer and deeper this crash, more money you will eventually make.
Fo a long term investor, equity is good precisely because it crashes. Volatility is your friend, and volatility is what will make you reach.
Wishing all of you happy Diwali and a very prosperous new year.