MFs in a spot over CRR hike

The hike in bank's cash reserve ratio (CRR) has pushed the domestic debt mutual fund industry into a corner. With the supply of liquid paper in the market having dried up mutual funds are working on new trading strategies to protect their invested capital as also to generate return for their unit holders.

The supply of liquid debt paper has dried up in the market since banks are not trading much for fear of having to book capital losses in their books.

The situations seems to be taking serious contours since banks are transferring their holdings of tradeable securities to the 'Held to maturity' segment, which saves them the pain of having to mark to market their portfolio. For fund houses, this means they will not be able to churn their portfolio as aggressively as before to generate returns.

"They (the funds) will churn only a small portion of their portfolio," said Sandesh Kirkire, head of debt funds at Kotak Mutual Fund.

Fund managers said that instead of churning the portfolio to generate profits, they would have to look for coupon accruals as a way to generating returns.

At least till earlier this year when the interest rates were heading down, capital gains accounted for 50 to 60 per cent of a debt fund's returns. Now this is expected to be reduced to around five to ten per cent. This small portion of capital gains can come from `smart trading' through duration management, fund managers said.

Funds are already stopped taking any long positions in the market and have commenced trading at the margin, industry circles said.

With duration already down to between 2.5 years to 3.5 years there is very little that funds can do by way of further reducing maturities of their portfolios.

There is also very little liquidity at the shorter end of the maturity spectrum.

Portfolio maturities were close to 6 years in March this year and then were brought down to less than four per cent by June 2004.

Prior to the Reserve Bank of India's move to hike the cash reserve ratio last week some funds - with long term income schemes - had been staying away from the bond market largely due to the volatile conditions. These funds had been able to deliver returns in excess of 10 per cent until recently.