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MUTUAL FUNDS ARE IN CRISIS

The effect of global financial crisis is felt by the mutual funds in India rather than the Banking System. Even the debt oriented mutual funds, which are generally considered safe as compared to the equity oriented mutual funds are giving negative returns, which really tells the quality of the fund managers in those mutual funds.

Generally, investors with less risk apetite prefer debt oriented mutual funds which invest in Central Government Securities, State Developments Loans, Treasury Bills (Sovereign Debt) and other short term debt instruments like Certficate of deposits (issued by Banks), Commercial Papers (issued by Corporates) and Non SLR Bonds. These investments give a steady income flow to the investors with low risk. The secondary market for SLR securities is quite liquid and valuations are more or less transparent. But in case of CD/CP/ Corporate Debt, the secondary market is not very active and there are very wide fluctuations in their pricing. Therefore, in case of huge redemption pressure, the funds are not able to sell the CD/Corporate debts at competitive market valuations. In the last few days, when these mutual funds faced redemption request, they could not borrow from the market by selling these CDs/ CPs in the secondary market. They could not even borrow from the CBLO/Repo because they did not have enough SLR securities in their portfolio.

During the last few weeks, Short-term debt markets have been under considerable strain as it got tougher for funds to meet withdrawal requests. Money-market funds have been hurt by their inability to sell back at par the certificate of deposits and commercial paper they bought from banks and other issuers. To help the Mutual Funds to meet out the crisis, the Reserve Bank has temprarily allowed banks to borrow from RBI under special Repo for 14 days and lend the funds to Mutual Funds against Certificate of Deposits. It also allowed Banks to buy back their own CD, which is not permissible in normal circumstances. But these steps, I think, are not sufficient in long run. The real problem is the valuation and liquidity in the corporate bond market, poor risk management in managing mutual funds portfolio and lack of proper regulations in the Mutual Fund industry.

The money invested in the Mutual funds are a substitute for Bank deposits but they do not attract any cost for themutual funds as there is no contract to give interest to the customers. To safeguard the interests of the investors, a proper regulatory framework needs to be put in place in India.

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