“River Crossing” in Mutual Funds

This economic times article talks about “river crossing” in mutual funds.

“River crossing, or parking or holding period return, is a rampant practice, which takes place mostly at the financial year end when mutual funds connect with cash-rich entities to tide over redemption pressure. Regulators normally consider the practice imprudent since it raises investor risk.”

“This time the redemption pressure was somewhat higher in the middle of the year, triggered by the Amtek Auto fiasco

In September, CD rates had spiked about 25 basis points across maturities as banks aggressively raised money to shore up their deposits ahead of quarterly earnings. But, this time, the rates slid following RBI’s borrowing cost reduction exceeding estimates.

At the same time, mutual funds, the biggest buyer of CDs, face redemption pressure in their liquid and ultra short-term funds as lenders want to avoid setting aside any extra capital for MF exposure to maintain a good capital adequacy ratio.

At this point, some intermediaries or brokers connect with a few cash-rich entities, be it corporates or bankers, which extend funding support to MFs by temporarily buying CDs at higher rate than normal.

Beginning next quarter (October), those financial entities sold back CDs to MFs at a predetermined price. The price is calculated in such a manner that the financing institute gains 10-20% annualised return for 5-10 days.

For instance, state-owned Syndicate Bank’s CD maturing mid-December has been traded at a high of 7.61% against a normal rate of 7.05% on October 1, said two market sources. On October 5, Andhra Bank and Axis Bank CDs yielded 7.63% each with both maturing in November-end.

“It is unwise for mutual funds to participate in this practice,” said Dhirendra Kumar, CEO of mutual fund portal Value Research. “The gains are few and if something goes wrong, the potential damage to reputation is immense. Showing higher asset for a few days can hardly be a big achievement.”

“Such practices could chip away at investor confidence just at a time when they have started reposing faith on the industry,” he said.

Selling and buyback of CDs at pre-determined rates are prohibited if reversal of trades are happening in the secondary at unusual rates,,” said a treasury head of a large bank.”

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Author: Bobbur Abhilash

I am a fourth year Doctoral student in the Finance and Control Department at IIM Calcutta.

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