Closing loopholes
Can you earn returns from a fund without investing in it? It may boggle
your mind, but, surprisingly, many large investors had been doing so.
Can you earn returns from a fund without investing in it? It may boggle your mind, but, surprisingly, many large investors had been doing so.
The Securities and Exchange Board of India (Sebi) has now cracked the whip on such shenanigans. It has asked fund houses not to allot units of liquid funds to investors unless the entire amount for the units is paid into the scheme account by the cut-off time. To ease the process, Sebi has also increased the cut-off time from 12 noon to 2 pm.
What was the modus operandi?
Large investors, mostly high networth individuals and institutional investor, would place an order for units of a liquid fund without making a payment or just paying a partial amount.
The funds would be allotted to these investors at the previous day's net asset value (NAV) on the condition that the full amount would be paid by the end of the day.
However, at around 3 p.m., the cut-off time for investments in liquid plus and other shortterm bond funds, they would switch to these funds. This would enable them to get one day's return on liquid funds, even though they had never invested any money.
"This practice allowed fly-bynight investors to gain at the cost of others," said an executive of a mutual fund house. This is because the NAV of a scheme is calculated by dividing the total asset of the fund by the number of outstanding units.
If investors are allotted units without taking the amount, the assets remain the same, while the number of units increases, thus pulling down the NAV. This system was putting the fund houses at a high risk as the amount of investment in case of liquid funds is usually very high. However, as the loophole allowed fund houses to garner more inflows, they were continuing with it.
In a recent circular, Sebi said that "as a matter of good practice and to avoid systemic risk, mutual fund houses must ensure that the money is available for utilisation before the cut-off time without availing any credit facility, whether intra-day or otherwise, by the respective liquid schemes.
What will be the effect?
Sebi's move will discourage fly-by-night investors and protect the interest of serious ones, resulting in an increase in the average holding period in liquid funds.
However, fund houses are apprehensive that the new regulation will negatively impact inflows into liquid funds. The fixed income head of a large fund house has admitted that a lot of float money that used to come to liquid funds may reduce drastically now.
The Securities and Exchange Board of India (Sebi) has now cracked the whip on such shenanigans. It has asked fund houses not to allot units of liquid funds to investors unless the entire amount for the units is paid into the scheme account by the cut-off time. To ease the process, Sebi has also increased the cut-off time from 12 noon to 2 pm.
What was the modus operandi?
Large investors, mostly high networth individuals and institutional investor, would place an order for units of a liquid fund without making a payment or just paying a partial amount.
The funds would be allotted to these investors at the previous day's net asset value (NAV) on the condition that the full amount would be paid by the end of the day.
 The Problem
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"This practice allowed fly-bynight investors to gain at the cost of others," said an executive of a mutual fund house. This is because the NAV of a scheme is calculated by dividing the total asset of the fund by the number of outstanding units.
If investors are allotted units without taking the amount, the assets remain the same, while the number of units increases, thus pulling down the NAV. This system was putting the fund houses at a high risk as the amount of investment in case of liquid funds is usually very high. However, as the loophole allowed fund houses to garner more inflows, they were continuing with it.
In a recent circular, Sebi said that "as a matter of good practice and to avoid systemic risk, mutual fund houses must ensure that the money is available for utilisation before the cut-off time without availing any credit facility, whether intra-day or otherwise, by the respective liquid schemes.
What will be the effect?
Sebi's move will discourage fly-by-night investors and protect the interest of serious ones, resulting in an increase in the average holding period in liquid funds.
However, fund houses are apprehensive that the new regulation will negatively impact inflows into liquid funds. The fixed income head of a large fund house has admitted that a lot of float money that used to come to liquid funds may reduce drastically now.
