The new set of norms prescribed by the Securities and Exchange Board of India (Sebi) to value bonds may affect the net asset value (NAV) of fixed maturity plans (FMPs) and other debt funds as fund houses may be forced to mark down their holdings.
“Fund houses that have purchased bonds aggressively will need to lower the NAV. The valuation of bonds will reduce over a period of time, depending upon the time left for their maturity. In turn, the volatility in the NAV too will reduce,” said Parijat Agrawal, head-fixed income, SBI Mutual Fund.
Under the new method of valuing bonds, Sebi has allowed mutual funds to lower or increase the price of bonds by a greater margin. For instance, bonds with durations up to 2 years can now be priced at 150 basis points (bps) lower (earlier 50 basis points) than the Crisil valuation (a valuation matrix designed by Crisil to value bonds on a day-to-day basis).
However, though bonds can be marked down more, the main issue is the illiquid nature of such bonds. That is, if a fund is valuing a bond at 50 bps below the Crisil valuation, but the bond can only be sold at a discount of 200 bps, then the valuation goes awry. And in situations where a fund house has to sell off some of its bond holdings, in case of redemption pressure, this differential will affect its NAV.
The revised norms for valuing debt securities will make the valuation of these bonds more realistic, said fund managers. “Minus 150 bps is definitely a more realistic way of valuing bonds than 50 bps,” said a debt fund manager, who did not wish to be named.
Of course, the price rise or fall is completely notional, unless the fund manager has to sell the bond. However, with reports of redemption pressure on funds, many have had to sell these papers, especially issued by the real estate and non-banking finance companies (NBFCs). When the selloff happens, the value that the buyer is willing to pay comes into the picture. And, if these papers are illiquid, even this 150-bps markdown may have little meaning.
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According to debt fund managers, the marking down of underlying assets may not happen immediately because of expectations that the improvement in liquidity conditions would make life easier for companies and banks. “But over a longer period of time, such a move will help funds,” said the debt fund manager.
There is another fear. If fund houses were to actually mark down the value of papers, NAVs would slip. This could easily lead to a reduction in investor confidence in fund products. “If they mark down their assets, investors will get worried about these funds because this will translate into a steep fall in NAVs. In fact, between Friday and Monday, the drop in NAVs of a few funds was as high as 9 per cent, which may be on account of funds marking down their holdings,” said Dhirendra Kumar, chief executive officer of Value Research.