By Pankaj Pathak
Liquid funds carry no credit risk, no liquidity risk.
Is the statement true or false?
Ideally, the statement should be true. However, in the past few years investors have lost their savings even in liquid schemes which questions the way liquid funds are run.
In the past week, we have conducted two webinars, shared our views with the media and investors on the ongoing debt fund crisis. Why? Is our liquid fund in trouble? NO! Did we do anything wrong? NO! A big NO.
However, we are upset and proud at the same time. We are upset that investors have lost their money. Debt funds which are considered safe and liquid failed to make payout to the investors when demanded. And we are proud that we werenât one of them. We didnât let down our investors. We stood by our investment objective to ensure safety and liquidity for our investorsâ money.
Liquid funds or any other fund which is meant for short term goals ideally should avoid taking excessive credit or liquidity risk. The latest debacle shows that some debt funds have not fulfilled this basic requirement and took undue credit risk.
Why is taking risk in liquid funds so bad?
As the name suggests, liquid funds are short term funds that are meant to be liquid at all times. Which means that any security your liquid fund holds needs to be good enough (need to have enough credit) for buyers to buy when a fund manager wants to liquidate your funds, so he can pay you back. If the credit is poor quality, it becomes difficult to find a buyer.
Why would somebody take high risks in a liquid fund?
Yield hunting!! Returns! Higher returns!! Liquid fund investors were lured with higher returns. Investors fell for the temptation and parked their money which was probably meant for their contingency needs or their kidâs school fees which is due in six months or some other short term goal.
In a good market, things were fine, everyone was happy. However, it takes just one company to default, and everything collapses. Just like a house of cards. Because there is a negative sentiment which affects everyone around. This happened during the IL & FS crisis. Even a small segment of the credit market can create panic.
Time to be clear and careful
Quantum Mutual Fund has always been clear that returns in debt funds are capped and if we try to chase returns and ignore credit risk there is a possibility that you can even lose your principal amount.. There is a major downside to all these things and sadly the upside is capped, which simply doesn’t make sense. Yield hunting with disproportionate risk doesnât make any sense.
Therefore, it is extremely important for investors to choose a liquid fund that aims to mitigate the issue of credit risks (risk of default) and liquidity risks (unable to liquidate/sell the assets to meet redemptions) by investing in safer and more liquid instruments.
Since COVID-19 has elevated the nervousness spell across market categories, we reiterate this to all investors that these are not the times to try and earn some extra return from your fixed income investments. We believe that the sentiment in the debt market could turn adverse and that it may be prudent to be as risk averse as one can be in their investment portfolios.
Quantum Liquid Fund rightfully invests only in government securities, treasury bills and securities issued by a select few AAA-rated Public Sector Undertakings (PSU) which are shortlisted under our proprietary credit research and review process. The fund aims to have very high liquidity, minimum volatility and near zero chances of capital loss (credit risk â risk of default of interest and principal).
(The writer is the Fund Manager- Fixed Income, Quantum Mutual Fund Manager.)