Quantum Mutual Fund

The Dip in the NAV of the Quantum Liquid Fund - Explained

The NAV of Quantum Liquid Fund* suffered a major jolt on 16th July 2013. The NAV of the fund was markedly lower than that of the previous day. This does not happen very often and investors do associate returns of liquid fund to always be positive and stable.

It has been so over the years, but there could be days of high market volatility where even the NAV of a liquid fund, over a short period of time, can remain below its previous days NAV.

This holds true especially for the Quantum Liquid Fund. The NAV of the Quantum Liquid Fund, since 1st July 2012, is completely mark-to-market (MTM); which means that every day the assets of the fund are valued at the 'fair' value at the end of day; against a prior practice of calculating NAV by 'amortizing' the assets. (In amortization, the asset value is increased daily by the interest accrual and is thus not marked-to-market and may not represent fair valuation at all times).

So, in a fund with daily MTM, if market yields (interest rates) move up, the price of the asset for that day will move down and vice versa. (In bond markets, generally, when interest rates go up, the price of a security goes down and if the market interest rate goes down, the price of the security goes up.) In July 2012, when Quantum Liquid Fund valuation methodology moved from Amortization to the Mark to Market, we had foreseen such circumstances and had cautioned our investors at that time.

The QLF NAV fell on 16th July, which means that market interest rates went up. The fact that it fell by 0.28% also suggests that the yields went up by a large margin.

Let us examine what led to the rise in market interest rates and its impact on QLF.

The Reserve Bank of India (RBI), through an unprecedented series of moves, announced on 15th July that it will:

1. Cap the amount of liquidity available everyday to banks at the Repo rate (7.25%) under LAF (Liquidity Adjustment Facility) to INR 750 bln (1% of the Banks Net Demand and Time Liabilities)
2. Ensure that the Daily Liquidity requirement above INR 750 bln would have to be then borrowed at the MSF (Marginal Standing Facility) rate which now stands at 10.25% hiked by a sharp 200 bps from the earlier 8.25%.
3. Further tighten liquidity, by selling government bonds to the market to the tune of INR 120 bln in what is known as OMO (Open Market Operation) sales. In an OMO sale, the RBI sells government securities and accepts cash from the market, thus leading to lower liquidity in the banking system

Sounds confusing? In simple words the RBI is trying to:

1. Increase short term interest rates by forcing banks to borrow excess funds at 10.25%. So as banks themselves start borrowing @ 10.25% daily, the overnight rates would move higher and thus yields on all other short term instruments would also increase to reflect the increase in overnight borrowing costs.
2. Increase yields on government bonds through OMO sales. This sale of bonds is an extra supply that the market will have to bear, which may lead to a rise in bond yields.

Why has the RBI taken these steps:

This has been done to control the slide of the rupee. One wonders though what have domestic interest rates got to do with the Rupee?

Rising Indian interest rates would make Indian fixed income assets more attractive to the foreign investor and thus attract more money into the Indian bond market. This is crucial as foreigners have sold more than USD 7 bln (net) in the bond market since the middle of May on lower yields and on fears of rupee depreciation. These sales by FIIs was a prime reason for the large depreciation in the Indian rupee in the last 2 months.

The RBI hopes that with interest rates back at attractive levels post these moves, it will draw foreign flows back into the country and help the Rupee to stabilize. We believe that they will meet that objective of attracting bond flows in the months to come which should also help the INR to stabilize and prevent any large depreciation.

What was the impact on markets:

Since the current market liquidity is already negative by more than INR 750 bln (banks borrowed INR 930 bln from the RBI on 15th July under LAF), the capping @ INR 750 bln would mean that the borrowings above that amount would happen at 10.25%.

Thus short term rates rose sharply on 16th July adjusting to this phenomenon. Money market instruments (T-bills, Bank CDs) of upto 1 year maturity saw an increase in yields in the range of 200 bps (2%) - 300 bps (3%).

Due to the OMO sale, the government bond yields and corporate bond yields also rose sharply and saw an increase in yields of 30 bps to 100 bps. The OMO sale along with the weekly auctions would mean the markets would have to absorb very high supply and this may have to happen at higher yields.

Instrument Yield on 16th July Yield on 15th July Yield on 15th May
3 month Treasury bill 9.25% 7.48% 7.34%
3 month PSU Bank CD 9.70% 8.02% 8.07%
5 year AAA PSU corporate bond 9.47% 8.74% 8.17%
10 year government bond 8.10% 7.56% 7.16%
(17th May , new 10 year issue)
         (Source : Bloomberg)

Since the Quantum Liquid Fund is completely mark-to-market and despite holding assets maturing only till September 2013 (less than 2 months), the fund's NAV was adversely impacted as yields rose across the maturity curve.

Outlook

There are chances that the RBI is likely to continue with these measures for at least 2-3 months and gauge the impact of these measures in stabilizing the INR and attracting capital inflows. Thus the expectations of liquidity to remain tight and market interest rates to remain elevated.

For the long term the increase in market yields would offer some very good investment opportunities for long term patient investors. So although your existing investments have taken a short term hit, but fresh investments and incremental NAV movement will happen from the new elevated levels.

But given that these are uncertain times, we expect market to remain volatile, which would mean that the NAV of the Quantum Liquid Fund would also gyrate in the short term depending on the daily market movements. Disconcerting as it may be, we believe that over time the volatility smoothens out.(see chart I)

Chart I : QLF NAV Series as reported and under amortization
Past Performance may or may not be sustained in the future and may not necessarily provide a basis for comparison with other investments.
(Source :Bloomberg)

(The red line shows the Quantum Liquid Fund NAV as it is on an MTM basis. The blue line indicates the NAV for the Quantum Liquid Fund when calculated on an Amortized basis. There is barely a discernable difference between the two when compared for the period of 1 year). For investors who need to understand this better, please write to us at [email protected] Despite the uncertainties and volatility in the market, the Quantum Liquid Fund is committed to have;

1. A highly liquid portfolio - we will not need to access the RBI special window to meet our portfolio liquidity requirements
2. A portfolio with high credit quality
3. A portfolio to provide optimal returns
If you have any further queries, please send us an email at [email protected]. We will be happy to answer any queries.

PRODUCT LABEL
Reach Us At
Toll Free Helpline
1800-22-3863 /
1800-209-3863
Sms
<QUANTUM> to
9243-22-3863


Risk Factors: Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
Please visit - www.QuantumMF.com to read Scheme Specific Risk Factors. Investors in the Scheme(s) are not being offered a guaranteed or assured rate of return and there can be no assurance that the scheme's objective will be achieved and the NAV of the scheme(s) may go up or down depending upon the factors and forces affecting securities markets. Investment in mutual fund units involves investment risks such as trading volumes, settlement risk, liquidity risk, default risk including possible loss of capital. Past performance of the Sponsor / AMC/ Mutual Fund does not indicate the future performance of the Scheme(s). Statutory Details: Quantum Mutual Fund (the Fund) has been constituted as a Trust under the Indian Trusts Act, 1882. Sponsor: Quantum Advisors Private Limited. (liability of Sponsor limited to Rs. 1,00,000/-) Trustee: Quantum Trustee Company Private Limited. Investment Manager: Quantum Asset Management Company Private Limited (AMC). The Sponsor, Trustee and Investment Manager are incorporated under the Companies Act, 1956.
© Quantum Asset Management Company Private Limited