The Securities and Exchange Board of India's fresh guidelines to safeguard debt investors' interest in the wake of recent defaults are worth applauding. The regulator has taken steps to distinguish liquid funds by making it mandatory for such funds to hold at least 20 per cent in liquid assets such as cash, government securities and T-bills. Though the move may eat into the overall portfolio yields, it will lower liquidity risks. The reduction in sectoral cap to 20 per cent from 25 per cent earlier and a cut in the additional exposure in HFCs from 15 per cent to 10 per cent will help avoid concentration risk.
The graded load on exiting the fund within seven days will nudge institutional investors to migrate to overnight funds, protecting liquid portfolio returns from lumpy flows. The much-awaited move to value all debt funds on mark-to-market instead of amortisation will ensure that NAVs reflect real portfolio values, although volatility may spike as a result. The market regulator has reminded mutual funds that their main activity is investing, not lending. Other guidelines include barring MFs from investing in unlisted non-convertible debentures and commercial papers, enhanced disclosures on encumbrance and cap on instruments with credit enhancements also known as promoter loans against shares. The new rules seek to instil discipline among fund managers, but may cause some loss of returns for investors during transition. Ample time and suitable grandfathering should make up for these losses.