Liquid funds turn less volatile in last 3 months, volatility likely to rise by end of yr

A trend story on liquid funds I did for the news orgn I work for currently:

http://www.cogencis.com/differentiators/ShareNews.aspx?newsId=1003654

[C] Liquid funds turn less volatile last 3 mo, likely to rise end of yr

Cogencis, Monday, Aug 28

    By Rajesh Gajra

    NEW DELHI - Investors in liquid schemes of mutual funds have seen returns

become steady in the last three months, after having seen highly volatile

returns in the preceding six months.

    In the last three months, liquid funds’ annualized returns have ranged

between 6.48% and 6.72%, while the preceding six months had seen it fluctuate

between a lower 6.00 per cent and a higher 7.08%.

    Fund managers expect lower volatility to continue for a couple of months

but expect a rise in it towards the end of the current calendar supply due to

liquidity pinch.

    In the current month, as of Wednesday, the median one month return of 45

liquid funds was 0.55%, while at the end of previous month and at the end of

June it was 0.56% and 0.54% respectively, an analysis of data from Value

Research's portal showed.

    This narrow band of 0.54-0.56% in the returns stood in sharp contrast to

the wide variance in returns seen from last November to end of May this year

when the median one-month return fluctuated between 0.50% and 0.59% and in

swings.

    For instance, the median one-month return fell sharply to 0.50% at end of

April from 0.58% a month ago, only to rise significantly to 0.59% at end of

May.

    Only returns from direct plans of the liquid funds under review were

considered.

LIQUIDITY SURPLUS

    "Abundant liquidity in the system is leading to low volatility in money

market rates (yields)," said Puneet Pal, head of fixed income at BNP Paribas

Mutual Fund.

    "Currently, there is a 2.5-trln-rupee liquidity in the money market,"

according to Deepak Agarwal, fund manager-debt at Kotak Mutual Fund.

    The last three months has seen this surplus range between 2.5 trln rupees

and 3 trln rupees. Much of it is the money which has continued to remain in

the banking system after demonetisation.

    Post-demonetisation, while the Reserve Bank of India has been active in

sucking out liquidity through open market operations like reverse repo

auctions, the intensity has varied from month to month.

    On the one hand the RBI has been conducting open market operations to

suck out liquidity over the past several months, since April it has also been

intervening in the forex market by buying dollars to rein in the

strengthening rupee and in the process has added to the liquidity in the

system, said Agarwal.

    Liquid funds invest in debt paper of residual maturity necessarily less

than 91 days, as mandated by regulations. This is primarily through

investments in money market instruments where the maturity is less than 91

days.

    Generally, going by recent data, liquid funds invest 45-50% in commercial

papers, 15-20% in sovereign debt paper such as treasury bills and cash

management bills, and 10-15% each in bank certificate of deposits and

collateralised borrowing and lending obligation instruments.

    Other debt schemes of mutual funds like ultra short term debt funds,

short term debt funds and dynamic bond funds also invest a portion of their

assets in money market instruments. Further, a part of the debt portion of

balanced funds also gets invested in this segment.

    According to Securities and Exchange Board of India data total money

market investments by all mutual fund schemes was to the tune of 4.77 trln

rupees as of the end of July. But Association of Mutual Funds in India data showed the assets under

liquid funds to be 3.23 trln rupees, indicating a 30% exposure to money

market instruments being by funds other than liquid funds.

    Unlike liquid funds, the other funds can dynamically increase or decrease

their exposure to less-than-91-day debt paper based on their risk-return

assessment. But when they do chase money market instruments it tends to

reduce yields. Liquid funds’ returns get hit when this happens.

NEXT FEW MONTHS

    “I don't see any reason why money market rates should go up dramatically

in the next couple of months as liquidity conditions are likely to continue,”

said Pal.

    But from October onwards the festive season will lead to a temporary

drawdown on liquidity. And, given that one doesn't expect RBI to cut repo

rate any more till at least the end of the calendar, it might put some upward

pressure on money market rates, according to Pal.

    Further, goods and services tax-driven increase in working capital

requirements of manufacturing companies is likely to lead to a sharp increase

in the issuances of short-term commercial paper of 2-3 month duration,

according to credit rating agency, India Ratings.

    Since these commercial papers are likely to have tenures of less than 91

days, it could drive up the yields of liquid funds’ portfolios.

    According to Agarwal, seven-day borrowings by non-banking financing

companies increase during times of equity initial public offers and any

significant IPO or IPOs in the coming months could pep up the short term

money market rates.

    Another factor impacting liquid funds is assets growth which has seen a

decline in the last three months. Liquid funds recorded net outflows of

646.92 bln rupees in May, 127.39 bln rupees in June and 195.11 bln rupees in

July, against net inflows of 994.03 bln rupees in April.

    Some investor money has shifted from liquid funds to ultra short—and

short—term debt funds in search for higher returns, said Murthy Nagarajan,

head of fixed income at Tata Mutual Fund.

    When investor money flows out of liquid funds the yields should

technically go up from current yields as the money chasing the money market

instruments is that much less, he said.

    The next few months, therefore, is likely to be challenging for liquid

funds to generate attractive returns but it may just be able to successfully

do that if money market conditions support it.

The table below lists the trend in 1-month returns of liquid funds over the

past 13 months:

End of      Median 1-month       Annualised

            return               yield **

------      --------------       ----------

                       (In %)

            -------------------------------

Aug 2017*     0.55                 6.60

Jul 2017      0.56                 6.72

Jun 2017      0.54                 6.48

May 2017      0.59                 7.08

Apr 2017      0.50                 6.00

Mar 2017      0.58                 6.96

Feb 2017      0.51                 6.12

Jan 2017      0.57                 6.84

Dec 2016      0.53                 6.36

Nov 2016      0.56                 6.72

Oct 2016      0.58                 6.96

Sep 2016      0.57                 6.84

Aug 2016      0.60                 7.20

* As of Aug 23

** 1-month return annualised

Data source: Value Research

End