Important Update on Liquid Funds3 min read

July 2, 2020


Important Update on Liquid Funds3 min read

We would like to inform you that since 30th June, 2020 all money market and debt securities are being valued on a marked to market (MTM) basis rather than amortization basis which was earlier followed for securities having a residual maturity of up to 30 days. This comes to effect due to a recent SEBI circular which states, “Amortization based valuation shall be dispensed with irrespective of residual maturity of all money market or debt securities”. Sounds complicated? Let us understand this in simple terms along with the implications of the decision on you.

Earlier Practice

Before 30th June, money market and debt securities with residual i.e. outstanding maturity of up to 30 days were valued on an amortization basis. For example: A fund had money market and debt securities with less than 30 day maturity which would generate let’s say 3% return over the remaining 30 days. Then irrespective of the market price of these securities they were assumed to generate 3%/30 i.e. 0.1% return everyday till maturity. Thus, these securities generated stable returns every day without experiencing any undue volatility due to market considerations.

Current Practice

From 30th June, SEBI has said that asset management companies (AMCs) cannot do amortization based valuation on any money market or debt security. This implies that these securities will be simply valued based on their ongoing market prices irrespective of their residual maturity. Market price of these securities are susceptible to various factors like interest rate action, market uncertainty, debt servicing ability of institutions etc. Thus, there might be some volatility in returns generated by short maturity debt mutual funds due to prevailing market conditions going forward.

Implications on you

Liquid funds in general have a greater proportion of their portfolio invested in money market and debt securities with less than 30 day residual maturity. So, Liquid funds will be the most impacted by this move. Most of the other debt fund categories like money market, corporate bond etc. were being valued on MTM basis only before as most of their underlying securities have more than 30 day outstanding maturity, so they might not be much affected by this decision.

Daily returns on liquid schemes which used to be stable and positive in general, might end up being a little volatile based on the ongoing market conditions. But as these schemes have very low maturity, the interest rate impact on them will also be very small compared to a fund with higher maturity. In some exceptional circumstances like a sudden and big rise in interest rates or during highly uncertain markets like during the COVID-19 crisis you might end up seeing negative returns for a few days. But this will be a temporary phenomenon as if you hold the fund till maturity then you will earn the returns in line with the yield to maturity of the fund.

What should you do?

Try to match your holding period with the maturity of the debt fund. Park your money in liquid funds for at least 30 – 40 days. If you want to park your surplus for less than a month then consider doing it in overnight funds as they have zero exit load and no mark to market implication. Explore a curated list of high quality liquid funds.