IS IT DOOMSDAY FOR LIQUID PLUS SCHEMES POST JULY 01’ 2010?
As you all are aware, come July 01’2010, new guidelines for valuation of securities for MTM basis will come into effect & create more volatility in all the debt schemes including Liquid Plus schemes.
Based on new guidelines, any paper with residual maturity of more than 91 days will have to be Marked to Market (MTM) price & the NAV should reflect these day to day changes. So far investments in Money Market instruments of less than 6 months could be valued on accrual basis rather than on MTM basis. This was giving steady non volatile returns in both Liquid & Liquid Plus schemes (wherein most of the Liquid Plus schemes were posting positive returns on even day to day basis).
| Current Market Practice | Likely Scenario post July 01’2010 | |
| General Average Maturity Profiles | ||
| Liquid Funds | 40-50 days | 40-50 days |
| Liquid Plus Funds | 120-140 days | 100-110 days |
| General Exposure to MTM | ||
| Liquid Funds | NIL | NIL |
| Liquid Plus Funds | 0-10% | 0-10% |
Some thumb rule analysis based on new guidelines for MTM shows the following results:
- 10% Exposure to 4 month paper with 5 bps spike in yield can bring down one day returns by almost 50-60 bps
- 25 bps spike in yields in a portfolio with 120 day average maturity can still generate positive returns on a seven day rolling returns basis
Hence, this should give comfort to the investors that a reasonable average maturity in liquid plus of say 100-110 days post July 01’2010 with not more than 10% in MTM should generate positive (better than FD & Liquid Fund on post tax basis) returns over 7-15 days rolling return basis. Investors will now have to start getting used to exit load structures in Liquid Plus Schemes varying from 7-30 days based on the underlying average maturity profiles & MTM component of individual liquid plus schemes.
Will Liquid Plus Schemes outperform Liquid Schemes & Why? :
Currently the yield curve is very steep at the shorter end of the curve. Consider the following:
| September Maturity | 4.45% |
| 1st week Oct maturity | 5.05% |
| 1 year CD | 6.00% |
This yield curve is more pronounced also due to the fact that new guidelines will come into effect from July 01’2010 onwards. Hence, any investment in incremental maturity is giving a great yield booster to the schemes. All that the Fund Manager has to balance is on how much average maturity profile should they increase in liquid plus over liquid schemes to justify the higher risk adjusted returns in liquid plus schemes & what should be the exit load issues based on the underlying portfolios of individual schemes.
Hence, those who had written off liquid plus schemes post July 01’2010 should do a rethink as the said schemes are still capable of earning at least 25-50 bps higher than liquid schemes with better tax arbitrage (as DDT on Liquid Schemes is 28% v/s 22% in Liquid Plus schemes). Though Liquid Plus schemes can go negative on day to day basis, based on some calculations, if the average maturity profile is restricted to 100-110 days with very limited MTM component, these schemes can outperform both FDs & Liquid Schemes of same duration on positive returns on post tax basis on 7-15 day rolling returns (tax on FD interest is 30%).
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