The recent circular from SEBI on May 31st has put several conditions for restriction of redemptions by mutual funds. Currently, mutual funds can decide to freeze redemptions on any scheme if the Board of the AMC and the Board of the Trustees agree to it. We recently saw the case J P Morgan Mutual Fund. It two debt funds had and exposure of nearly Rs.193 crore to the bonds of Amtek Auto. When Amtek got into financial trouble, the bonds were downgraded by CRISIL. This led to a crash in the price of these bonds. With these bonds becoming illiquid, there was no way the fund could have handled redemptions. As a result they had to freeze redemptions, till the issue had got sorted out.
The recent SEBI circular has defined the conditions under which a mutual fund can restrict redemptions on mutual funds. Here are some of the key highlights of the circular.
Highlights of the SEBI circular…
- A freeze on redemption would be permitted only where there are systemic or market level issues which have the potential to create liquidity risk in the market overall.
- Company specific issues and rating related issues or even fund-related problems cannot be a criterion to freeze redemptions
- Any freeze on redemption can only be kept active for a period of 10 days during any 90-day cycle.
- Any redemption request up to an amount of Rs.200,000/- has to be honoured by the fund even when the redemption freeze is in progress
- Even in case of larger redemptions, the fund must redeem up to Rs.200,000/- and the balance can be under redemption freeze
- SEBI needs to be immediately informed whenever such a redemption freeze is announced
What it means for mutual fund investors…
For the mutual fund investors this is one more step to protect their interests. Mutual funds cannot freeze redemptions for random reasons. Now there is a clear policy under which the redemptions can be frozen. While the discretion will still remain with the boards of the AMC and the trust, the SEBI framework will bring more discipline into the whole process. There are six broad implications of this circular…
- Firstly, the discipline imposed on mutual funds will bring out a more organized approach to freeze on redemptions. Situations like J P Morgan can be avoided.
- Secondly, the SEBI has made it clear that redemptions can be frozen only in case of systemic risks. Company specific problems and fund specific problems can be an excuse for freezing redemptions.
- Thirdly, this circular will go a long way in reinforcing the faith of investors in mutual funds. Sudden freeze in redemptions can put a lot of people who depend on mutual funds as a liquid investment in trouble. This issue gets resolved through the circular.
- Fourthly, the 10-day limit on freeze of redemptions also helps mutual fund investors plan better. Even if I am a large investor with a substantial exposure to a mutual fund scheme, I can be sure that the freeze on redemptions cannot be held for more than 10 days.
- Fifthly, the 2 lakh threshold by SEBI is a great idea for investors who are depending on mutual funds for regular liquidity. Take the case of retired people and pensioners who have invested in mutual funds for regular withdrawals. That problem gets largely addressed through this circular.
- Lastly, this will put greater onus on fund managers to focus on risk of the portfolio as much as returns. In a bid to chase returns, many fund managers had gone down the rating curve. That situation can be avoided.
All in all, the SEBI circular is a great boost for mutual fund investors. Especially, small investors will stand to benefit immensely from it. It is surely one more step in safeguarding the integrity and independence of the mutual fund industry.