Of the Rs 3,40,000 crore in debt funds, FMPs floated by fund houses account for over Rs 1,00,000 crore. The FMPs indicate 11.5-12 per cent returns to investors, which coupled with the tax advantage they offer, promise to be much better than bank fixed deposits. The moneys are invested largely in certificate of deposits issued by banks, NBFCs and even in debt issuances of firms across sectors including real estate.

And unfortunately, the capital market regulator, the Securities and Exchange Board of India (Sebi) does not require MFs to compulsorily disclose their investment portfolio. Given that there is hardly any depth in India’s corporate debt market, a significant quantum of the debt held by such FMPs are illiquid.

“The problem lies here. When there are large-scale redemptions, the MF first sells debt securities that are liquid. So, investors who stay on with the scheme are saddled with illiquid paper,” says Dhirendra Kumar, managing director, ValueResearch, a firm that tracks mutual funds.

In fact, to counter this problem, Sebi on Saturday changed the formula based on which mutual funds value their bond investments. “Because of the tight liquidity conditions, spreads have widened. The change in the discretionary spread now allowed by Sebi will make MFs show a net asset value that is correct, and based on the market valuation,” says Roopa Kudwa, Managing Director and CEO, Crisil. MFs value their bond investments based on a daily value matrix Crisil provides.

What this effectively means is if yields of the underlying bonds where MFs invested rise, their market value will drop, resulting in a lower NAV of the scheme. This is what is happening today. Tight liquidity situation has resulted in yields shooting up and NAVs dropping. Investors in liquid, liquid plus and FMPs are, perhaps for the first time, seeing their investments lose value.

Sebi’s change in norms will push investors to stay on. “When the correct value of the bonds are reflected, their NAV will be lower. Corporates and other investors may now remain invested till the life of the scheme just to protect their capital,” said a fund manager who did not wish to be quoted.

But, in the recent past, corporate investors have exited lock, stock and barrel from such funds. A large IT company based in Gurgaon pulled out all its investments from debt funds after it faced losses in one of the schemes. “Losses in liquid schemes were never heard of,” says Dhirendra Kumar, adding that exposure to certain sensitive sectors such as real estate by some mutual funds is also adding to the speculative fire. Since the real estate sector is starved of cash today, there are doubts on the abilities of even the best companies in the sector to pay back the principal to the MF at maturity.

Kudwa says companies prefer to be cautious today. “It (the redemption pressure and its impact) will play out in the next few weeks and months. There are some schemes which have significant exposure to sensitive sectors.” Such schemes may face tough times if some companies default on their debt commitments.