Debt MFs vulnerable to large-investor exits: Financial Stability Report

Report says pullouts from funds could be concerted in times of stress

The Reserve Bank of India’s (RBI’s) Financial Stability Report (FSR) has highlighted that debt mutual funds (MFs) remain susceptible to exits from large-ticket investors, even as regulations have placed caps on single-investor holding in schemes to avoid concentration.

“Existing regulations specify single-investor concentration norms for diversifying the investor base. However, when the investor profile is dominated by risk-averse investors, as is the case in money market/debt MFs, there is a strong possibility of a few corporations distributing their surplus to over four-five fund houses, and hence, exits during times of stress could still be concerted,” RBI observed in its 21st issue of the FSR.

The existing regulations by the Securities and Exchange Board of India (Sebi) state that no single investor can hold more than 25 per cent of the corpus of an MF scheme.

Pointing out the risks seen during the pandemic, the FSR noted that high returns had “quickly turned negative in the wake of Covid-19-related dislocation”.

The report also pointed out that the chase for returns ends up masking the illiquidity premium in debt schemes, as higher returns attract incremental investor flows.

Further, the report stated that corporate investors are concentrated in large-sized schemes as smaller fund houses are unable to compete on expense ratios because of lower economies of scale. 

There is also a higher likelihood of bailout. "A large fund size is also incentive compatible from an investor point of view, as such funds have significant systemic spillovers, potentially improving possibilities of bailouts”.

The high share of corporate and high-net worth investors (HNIs) in debt funds make them more vulnerable to large exits. 

The report pointed out that corporate investors and HNIs accounted for 90 per cent of the aggregate assets under management in debt funds.

The report observed that debt funds’ risk-aversion has continued.

“The proportion of liquid securities in holdings of debt MFs reached an all-time high in April 2020, reflecting risk aversion and liquidity storing,” the report pointed out.

Corporate defaults have taken a toll on debt MFs. 

“Resource mobilisation by MFs suffered from idiosyncratic shocks such as corporate defaults during the second half of 2019-20, with pressure intensifying in March 2020. Open-ended debt-oriented schemes accounted for net outflows of Rs 1.94 trillion,” the report said.