HNIs or Institutional Investors – Retail Debt Mutual Fund Investors SILENT enemies

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Today I was reading the news that Reliance parked Rs.35,000 Cr from Jio stake sales in Ultra Short Term or Money Market Funds The whole world discusses interest rate risk, credit risk, or default risk of debt mutual funds. However, the recessions will pose one more type of risk to debt mutual fund investors. It is Liquidity risk in mutual funds.

Debt Mutual Fund Investors Risks

The recent example of such Liquidity Risk is panic selling by HNIs in Franklin Funds leading to close the funds. However, this is not the first instance that happened in the history of Mutual Funds.

HNIs or Institutional Investors – Retail Debt Mutual Fund Investors SILENT enemies

If we go back to the 2008 Lehman Brothers crash, the biggest event happened than what the Franklin investors are facing today.

Such a liquidity risk is mainly posed by HNIs than the retail investors. This results in herd behavior among all others who invested in such funds. It may happen to your Liquid Funds also. No funds are safe if we consider Liquidity Risk.

On Sept. 15, 2008, Lehman Brothers declared bankruptcy. Institutional investors knew that Reserve Primary, a money market fund, held a small position in Lehman Brothers’ debt. They were off to the races. Within five hours, YES, WITHIN FIVE HOURS! Reserve Primary had received redemption requests that exceeded 25% of the fund’s total assets.

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Let me give you the choronological events that happpend on that horrific day.

On Sunday, September 14, 2008, Lehman announced that it would file for bankruptcy protection the following day. In response to this announcement, on Monday morning, September 15, 2008, the Primary Fund faced a tidal wave of redemption requests.

By 8:40 a.m., redemption requests totaled more than $5 billion. At 10:10 a.m., State Street Bank and Trust Company, the Primary Fund’s custodial bank, stopped funding redemption requests and suspended the Fund’s overdraft privileges. Although redemptions were no longer being paid out, requests continued to pour in. By 10:30
a.m., redemption requests had doubled, totaling more than $10 billion. By 1:00 p.m., redemption requests had grown to approximately $16.5 billion.

The run on the Primary Fund continued throughout the day and into Tuesday, September 16. By 3:45 Tuesday afternoon, redemption requests totaled a staggering $40 billion or roughly two-thirds of the total assets under Fund management. The run on the Primary Fund coincided with a period of enormous turmoil in the credit markets that resulted in a near freeze of trading.

Do remember two things here that the Reserve Primary Fund is the first MONEY MARKET Fund. We always claim that Money Market Funds are safe. However, leading to such huge unprecedented redemption from HNIs or Institutional Investors, the Primary Fund was forced to announce that redemption requests received prior to 3:00 p.m. would be redeemed at a NAV of $1.00 per share.

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Redemption requests received after 3:00 p.m. would be redeemed at a NAV that attributed a zero value to the Lehman holdings, yielding a NAV of $0.97 per share. See id. The Primary Fund had thus “broken the buck,” becoming the first retail money market fund ever to do so.

The Primary Fund also announced a “seven-day redemption delay” on September 16, in place “until further notice.

The complete event can be read at HERE.

If you replicate what happened with the Reserve Primary Money Market Fund with the Franklin India Mutual Fund, the two events match exactly. The severity with which it happened with Reserve Primary fund may not be with Franklin India Mutual Fund. However, the end result is the same. The retail investors forced to suffer the liquidity risk because of such PANIC SELLING by HNIs or Institutional Investors.

Conclusion:-So what is the solution for retail investors to stay away from such risks? Currently, the answer is NO solution. However, as per my view, SEBI has to come out with clear notification and within the same fund, there must be two types like one for HNIs or Institutional Investors and another for retail investors (which was earlier).

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I know that those AMCs who received Rs.35,000 Crore from Reliance in their funds may have REJOICED. However, such investments always post a risk to retail investors. Beware!

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Basu Nivesh

Basu Nivesh

Basav is a SEBI Registered Investment Adviser (SEBI RIA) practicing the Fee-Only Financial Planning Service. He is a CFP (Certified Financial Planner) and blogger at Basu Nivesh. He services around 300+ satisfied clients.
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