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The flip side to listing

Listing of fixed maturity plans may not end the recent woes of this class of debt mutual funds.

Listing of fixed maturity plans may not end the recent woes of this class of debt mutual funds.

The huge redemption that Fixed Maturity Plans (FMPs) faced in October has renewed the debate on the structure of the product. The product invests in debt instruments whose maturity matches its own tenure. The idea is to buy and hold these debt instruments, and redeem them when the FMP matures, and pay out the proceeds to investors. An investor who holds the FMP until maturity benefits from the yield of the debt portfolio. However, fears about the quality of FMP portfolios, especially the real estate sector debt in some of them, triggered mass redemption pressure. This meant FMPs had to sell off their debt holdings before maturity, mostly at a loss. The secondary market for debt instruments is very illiquid, and a desperate FMP seeking to honour redemptions is unlikely to get fair value. The impact of this redemption has been on both who redeemed (at a loss and at a high exit load) and on those who chose not to redeem, as the NAV fell from the reduction in the value of the portfolio. There is a rightful demand for protecting the interests of those investors who stayed invested, but suffered a loss due to the actions of those who redeemed in panic. The only way this insulation can happen is by asking FMPs to list. This creates two problems. First, FMPs operate on very thin margins and are issued at high frequency. The listing fee will be high, and this will cut into the yield. Second, secondary market liquidity is likely to be low (the redemptions are more an act of panic than a regular need) which means that prices will not be efficient and will differ from the NAV of the product.

Welcome the firewall
The other proposal is to separate institutional and retail plans of liquid funds into separate schemes. This is a welcome move, and fairly easy to implement. Currently, the underlying portfolio is the same; the various plans in a fund are different only to the extent of the expense ratio. Therefore, the NAV of different options is computed from the value of the same underlying portfolio, which is then apportioned on the basis of net assets, to apply the expense ratio and arrive at the NAV. This means if the underlying portfolio value is impacted by the redemption pressures of institutional investors, the NAV of the retail option also falls. By separating the portfolios, the net assets of one segment are insulated from the redemptions in the other segment. However, most benefits of a liquid fund arise from size. A retail liquid fund may not have a large enough corpus to reap those benefits. That may still remain a limitation.

Realign incentives
The R. Kannan Report on lapsation of insurance policies has rightly recommended uniform industry practices to deal with situations of discontinuation of insurance premium. Among the reported findings of the white paper is the abnormally high lapsation in unit-linked insurance plans (Ulips). Against an average of 6 per cent lapsation, 18 per cent of Ulips lapsed. The reasons may not be hard to find. First, investors eye the tax benefits and commit to insurance premia that are well above their ability to pay. They then tend to discontinue paying the premia when they find the going tough. Second, since commissions are front-ended there is little incentive for the agent to focus on continuation of the policy. It is common for policies to be discontinued after a period of three years. A high lapsation rate is not only bad for the investor but also for the insurance company, which ends up getting unreliable short-term money into what was designed and managed as a long-term product. The only beneficiary in a lapsed policy is the insurance agent. The incentive structures need to be revised to ensure that the interests of investors and insurers are also protected.

Wise up and lower prices
Real estate developers have been sending out conflicting reports. While some have admitted to prices falling already, or the need to allow housing prices to fall, others contend that demand will be spurred if interest rates are reduced. The real danger is from the inefficiencies in price discovery in property. Since the deals are negotiated, and often involve too many differences in what is included or excluded, apart from the ubiquitous cash component, one can only know the broad trend, but not the actual price and its correction. Additionally, when buyers know that demand is slack, they tend to wait for a further fall in prices. It is also unlikely that loan rates will come down too much, too soon. And even if they do, the demand for luxurious flats that remain unsold is unlikely to pick up soon. It would therefore seem that after some posturing the industry will concede lower prices.

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First published on: 24-11-2008 at 15:45 IST
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