Product differentiation in Debt Funds: India

From mere Assured Returns of 1970-1990s, the debt funds found themselves emerging as MIPs without assured returns led by Birla Mutual Fund, ICICI Pru etc.. during the early years of opening up of the industry to private players. MIPs offered a certain periodic cash flows at predetermined frequencies(Monthly, quarterly, half yearly and annally).Money Market Instruments like Certificate of Participation, Certificate of deposits and Interbank Participation Certificates got introduced in 1988-89. Side by side another class evolved the Money Market Mutual Funds (April 1992) . Private Sector was allowed to launch MMMFs by 1995-1996. UTI News, October 1996 has a mention that MMMFs as a class has gained popularity and tehy would also like to introduce the same shortly. But the first AMFI newsletter October 1998 has not captured this as a separate class, though the ELSS has been recognized. But there is a mention that cheque writing facility has been granted for MMMFs in the Newsletter dated April 1999 that such cheques would not have the characteristics of the negotiable instrument.By1999, bond funds drifted silently to the maturity matching versions of MIPs called serial plans. Kotak Mahindra Mutual fund was th efirst to have this in their fold, soon copied by others like Dundee, Sun F&C and Prudential ICICI with maximum maturity of 3 years, such schemes subsequently got legalised as Fixed Maturity Plans(FMPs). They gave safety of bank FDs and ease of Current Accounts simultaneusly. Probably the parenthood (Bank , FI sponsored MFs) had a bearing on designing new products. Cash rich Institutions and Companies in fact were holding major chunk in such schemes. SEBI intervened to wipe off solitary member schemes by 2003.Income Distribution Tax on schemes with less than 50% exposure to equity was imposed in 1999 @ 11% and then hiked to 22% in 2000-2001. By 2005-2006, the FMPs were fully established. Even today the FMPs score over conventional FDs on several aspects.In 1998 RBI cleared the way for Gilt Funds that primarily invested in govt paper and Kotak Mahindra Mutual Fund took the credit for pioneering it in 1999 .Today we have both short term and long term gilt funds.In February 2002, SEBI permitted MFs to invest 4% of their Net Assets in high quality, convertible currency, Govt/Non-Govt instruments subject to maximum of $50 million. This opened a new world of opportunities. Franklin India International Fund (Dec 2002) is an example.There is Debt Funds that specialise in Corporate Debt paper. ING Select Debt Fund (Sep 2004) is such one.Debt Funds in General can be classified into 3 groups:
1. Passive Funds (Income and gilt funds) do well in the falling markets
2. Active Debt Funds (also called Dynamic funds) do well in a volatile market and
3. Accrual Funds(Other wise called Floating Rate Funds, Liquid funds) do well in a rising market

They give best results in the respective market condition. But Indian markets saw Standard Chartered All Seasons Bond A (Aug 2004) is a Fund of Funds that has been designed to perform in all the three market conditions.When derivatives were opened for MFs, Arbitrage Funds found their way into the market. The first such fund was offered by M/s. Benchmark AMC. The Benchmark Derivative Fund with a self imposed AUM of 100 crores was launched in Dec 2004. The corpus limit lifted by 26 April 2005.Debt Funds started declaring dividend(income distribution) at chosen intervals otherthan the traditional monthly, quarterly and annual versions climbing the waves of tax-free dividend(income distributions). The liquid versions with floating interest rates linked to PLR of a chosen bank, MIBOR or LIBOR, CRISIL Balanced Index etc.. started filled the vaccum.By Mid 2005, we find a lot of interval funds coming to the market. The CPOSs got christened by SEBI in August 2006.As more and more interval funds started coming, the fund houses recognized that they can save on OD filing fees and attended procedures of FMPs. The first of its kind came from HDFC Quarterly Interval Plan A(March 2007). Investor anyway gets the benefit of enhanced returns resulting from the hedging strategies. Also the subscription and redemption intervals are fixed. Investors were aware of the additional risk of the market expectation that the fund manager undertakes in creating that extra. So FMPs continued to exist with 1 month, 90 days, 180 days, 366 days 550 days etc.. helping investors to reduce Interest Rate Risk.When SEBI noticed that the FMP funds were primarily finding deployment in Bank FDs in an urge to improve AUM, 15% cap was installed on such temperoray fund allocation by MFs.The old fashioned MIPs without Assured Returns shrink in AUM. Total AUM of the 31 MIPs stood at 2923.57 crores as at 31 March 2008. Except the HDFC MF, no other fund house got a MIP of decent size by 31 March 2008.2008 saw the Equity Index Linked editions of FMPs with ICICI Pru taking the lead.

A new class of 'liquidplus' arrived by 2007 budget imposing a Tax of 25% on income distribution of liquid funds. They operate on the short term end of the liquidity spectrum but little away from Money Marklets.

During October 2008, they landed up in trouble with liquidity getting dried up and banks in no mood to fund them. Finally SEBI came up with diluted valuation norms for valuing debt assets of MFs, RBI came out with special liquidity window for the MFs in addition to other liquidity infusing measures.

SEBI also tightened the exit facility in these funds by insisting listing of closed end schemes; specifying the maturity limits for instruments to go into the portfolio and also mandating that no indicative yields or portfolio could be publicised in the debt funds.

The FMP floated by ICICI Prudential was withdrawn due to lack of response; Principal Mutual Fund changed thier scheme name to principal Ultra Short term Fund with mandate to invest in debt securities and money market instruments in the Opened end class.ING responded by merging two or its schemes and making the 'Multi-Manager ' to prevail.