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Beware of Mutual Funds That Offer Instant Redemption!

In the recent past, three mutual funds houses (Reliance, DSP Black Rock and SBI) have launched a facility in which it buys back units from its investors and instantly credits the equivalent value into a registered bank account. At first sight, this seems like a wonderful idea. However, on closer inspection, we begin to understand why SEBI has reportedly "expressed concern" about this move.

Thanks to Anish Mohan's research (see below), none of the schemes that offer instant redemption are liquid funds. They are, what is informally known as ultra-short term funds. Informally because, with the exception of liquid funds (that can only invest in bonds maturing on or before 91 days), there are no rules with regard to where other debt fund schemes can(not) invest. So we should not be surprised if a "banking and PSU" debt fund holds about 20% of GOI bonds with the hopes of riding the interest rate fall.

Instant redemption from a liquid fund makes a lot of sense as it meant for parking money. Then it is as good as a saving bank account. But why an ultra short-term fund? Why would we need instant redemption from an investment vehicle? With such funds not having a clear investment mandate, the instant redemption facility can result in unnecessary redemption pressures in the event of an abrupt interest rate increase, a credit rating downgrade or a market-wide crisis. Everyone agrees that equities are risky, but not many investors understand the risks associated with debt funds. Offering instant redemptions from schemes where such risks can be significant is asking for trouble.

SEBI is being reactive by expressing concern. It can do even better by being pro-active and offer clear investment style guidelines for both debt and equity funds. This will help investors categorise risk and invest accordingly. Until then, I will stay away from any scheme that offers instant redemption.

Now over to Anish.

-=-=-=-=-

The following funds provide instant redemption facility to investors

  1. DSP BlackRock Money Manager
  2. Reliance Money Manager Fund
  3. SBI Savings Fund

Now if I would delve into the Scheme Information Document (SID) of the above funds, the following are my observations. I would pick up key elements from the SID

The SID of DSP BlackRock Money Manager says  “The weighted average maturity of the Scheme will be less than or equal to 6 months” which makes it an Ultra Short Term fund.

Now notice how Reliance Money Manager has positioned its asset allocation in the SID. Up to a maximum of 100% can be invested in Debt Instruments including Government Securities, Corporate Debt, Other debt instruments and Money Market Instruments with average maturity less than equal to 12 months whereas Debt Instruments with average maturity greater than 12 months can be present to the maximum extent of 50%.

I would be circumspect on such a wide variance of average maturity and given a chance where the Debt instruments greater than 12 months’ duration and less than 12 months’ duration comes to a 50:50 ratios, the average maturity can easily be higher than 1 year. That surely will not qualify it to be an Ultra Short Term at that instant.

Coming to the new kid round the block, SBI Savings Fund comes with a piquant situation. The SID does not even obscurely put any restriction on the mandate of average maturity and neither they can be assessed objectively. It mentions that Fixed/Floating rate Money market instruments will include Commercial Paper, Commercial Bills, Certificates of Deposit, Treasury Bills, Bills Rediscounting, Repos, Government securities having an unexpired maturity of less than 1 year.

At the same time, the SID goes ahead to confuse investors by mentioning “Investment in Corporate Bonds and Debentures in the Scheme will be in securities with maturities not exceeding 3 years”. It even goes on to quote “This Scheme will be ideal for investors with a short-term investment horizon of not more than 1 year”. Well, leave that piece of advice for the reader of the SID to derive or conclude and simply abdicate such advice to the caveat lector clause. At the end of day, I don’t read SID to derive investment advice.

The discussion on the above 3 clearly indicates that the 3 funds are to fall under Ultra Short Term category with DSP Blackrock having 100% certainty that it will always remain an UST, as long as the SID stays sacrosanct. At the same time, this has driven home the point, that, in no way, mutual fund providing the facility instant redemptions are liquid funds by even any stretch of imagination. There are no Liquid funds as on today, who provide instant redemptions and demonstrate to be truly liquid.

My personal take on this instant redemption is a mixed bag. There is a lot of myth that Liquid funds or even Ultra Short Term funds are a panacea to easy liquidity in Mutual Funds and is no less an alternative to Savings Bank Account, if not better. Data manipulators will simply do a lot of number crunching to demonstrate that the category average return for Ultra-Short Term funds for the past 1 year is 8.65% whereas for liquid is 7.51%. And when compared to banks, simply do not stand any comparison with zero interest on current accounts and 4% on savings account. I find this rationale preposterous. My savings account is for a different purpose compared to my mutual fund investments and no one can replace the other. So UST replacing bank account is ruled out.

However, instant redemption is a psychological feel of how liquid is my investment and I hate to wait for 2 business days for my funds to get credited in. So, instant redemptions give that comfort feel, and it is purely a psychological feel rather than a pivotal factor for investing in UST or Liquid fund. I would like to invest in a genuinely-liquid Liquid fund and would find resonance in the theme of instant redemption tagged to Liquid funds. Till that time, it’s just a nice-to-have and makes no difference.

-=-=-=-=-

Not much difference to the investor (other than the illusion of getting money back instantly), but big difference to the AMCs who can use this "psychological comfort" for gain.

I hope sanity prevails and SEBI bans instant redemptions from non-liquid funds and btw does not allow investments from wallets.

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17 thoughts on “Beware of Mutual Funds That Offer Instant Redemption!

  1. SENTHILNATHAN JEYAKAMESWARAN

    Layman question...I am planning to park portion of emergency fund in one of the instant redemption UST scheme. Even if i get less than liquid fund return i am ok, in this case is it advisable or not? - Thanks

    Reply
  2. Prasanna Rao

    I was using Reliance Money Mgr fund for the last 5-6 months and was happy with instant redemptions - they worked every time. However, yesterday when I did redemption, it treated it like normal redemption and I got the money only today.

    It is better to stay away from these, I am withdrawing all my funds from here.

    Reply
  3. Anish Mohan

    Emergency fund in a UST fund which does not have a tight duration or credit risk mandate is not a good decision. If you can find a UST fund which shall have a tight duration boundary of <6 months and a tighter credit risk of only PSU bonds of AAA category, then it might be okay. if I am sure you shall not find any UST with such conditions and therefore is not recommended.

    Reply
  4. Vivek

    @Prasanna: it would be great if you could elaborate... There are 2 aspects to instant redemption... AMC approving n clearing the request and of course imps...
    I have had my share of delays with imps...
    Was curious to know which one failed...

    Reply
  5. Hemanth Chandra

    forgive me if I am wrong. I think redemption requests only from app will be considered for instant redemption....have u redeemed from app ??

    Reply
  6. SENTHILNATHAN JEYAKAMESWARAN

    While Redemption you have to choose " AMOUNT" based and NOT unit based..If you choose UNIT based, then it's not Instant redemption. There is no specific buttons/menu options to FORCE instant redemption...UI is bad.

    Reply
  7. Arul

    I am holding Reliance Money Manager fund for many years and holding Reliance Anytime Money card. In the recent week, I was able to use the card in HDFC ATM and withdraw cash, which I found extremely useful and user friendly.

    Reply
  8. ajit kumar

    Try SmartDeposit with ETMoney app.
    Instant redemption is a liquidity feature and has nothing to do with which fund it comes attached to.
    If tomorrow a equity fund comes attached with ABC_Instant-redemption and ABC_Regular-Redemption which one would you suggest user to go with.

    Reply
    1. freefincal

      If an equity fund comes with instant redemption, I will not touch it. The convenience of instant redemption could well mean existing investors suffer. And more often than not we would be the existing investors.

      Reply
  9. ajit kumar

    Please explain how redemption feature hurts existing investor. And how existing T+2 redemption Vs Instant redemption will hurt existing investors of any scheme.
    It almost like saying for Banking customers in yesteryears when outstation cheque used to cash out on T+15 days was better than todays core banking T+3 days. Or even better it was better when you stood in queue for withdrawing cash than ATM's (though we are back in history Ain't we)
    🙂

    Reply
    1. freefincal

      Instant or T+2, if people rush to redeem, existing investors will suffer (NAV will drop because of redemptions). And by offering instant redemption in a product fraught with risk is asking for trouble.

      Reply
  10. Mohit

    @Pattu Sir, I am keenly looking forward to a blog of yours on how to declare Short Term Capital Gain On debt and Liquid funds in ITR2.

    It would be great if you can write a blog post on that.

    Thanks

    Reply
  11. Anjan

    Instant Redemption in Equity funds only makes sense if they keep the exit load intact. I would actually prefer if I get the money instantly than having to wait 3 days for no reason. If they remove the exit load too, during times of crisis, there would be huge redemption pressure and the NAV would take a nosedive.

    Reply
    1. freefincal

      And that 1% exit load will prevent redemption pressure because people fear losing 1% more than losing 25%?!

      Reply
  12. Anjan

    Even now people can redeem from equity fund anytime they want and they will get the current day's or next day's NAV. So what disruption can Instant Redemption cause? The only difference is getting the money instantly vs having to wait 3 days.

    Reply
    1. freefincal

      When redemptions increase, instant redemptions will close first. If they continue to increase, T+1 or T+3 does not matter. Everyone will suffer losses. Google: bank run on mutual funds.

      Reply

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