The recent move by the Securities Exchange Board of India (Sebi) to make chan-ges in the valuation methods of liquid funds and ultra-short-term funds could lead to investors leaning more towards liquid funds for stable returns, say mutual fund experts.

Anil Chopra, group chief executive officer, Bajaj Capital, said the new valuation method would queer the pitch for ultra-short-term funds because the higher returns they give would come with higher volatility. “Investors would now settle for lower, but more stable, returns of liquid funds than high-return, high-volatile ultra-short-term funds. In some cases, investors might even opt for shorter tenure bank deposits for risk-free returns,” he added.

Sebi has asked fund houses to mark-to-market the value of papers/securi-ties with maturity up to 182-days in which liquid and ultra-short-term funds invest. Industry experts say the new valuation method would make the net asset value (NAV) of liquid funds and ultra-short-term funds (earlier called liquid-plus funds) more volatile, but liquid funds being shorter tenure funds would be less volatile compared with ultra-short-term funds. Securities with over 182-day maturity are already valued at daily weighted average (mark-to-market) method.

Ultra-short-term funds such as liquid funds invest in money market instruments such as commercial papers (CPs) and certificate of deposits, with the only difference being that the former can hold securities with maturity over 91 days. Holding longer-term securities helps ultra-short-term funds give higher return than the liquid funds.

Anil Rego, CEO of Right Horizons, a financial adviser, said the new valuation method has resulted in ultra-short-term funds losing their advantage over liquid funds and other debt funds. “Now, with all debt funds being marked to market, investors would no longer remain attracted to ultra- short-term funds. However, liquid funds being low-tenure funds might still attract investments,” he added.

Last year, after Sebi made it mandatory for liquid funds to invest only in securities with maturity of 91 days, many fund houses started aggressively marketing ultra-short-term funds, which by virtue of being able to invest in longer-tenure papers gave better returns than liquid fund schemes.

According to experts, Sebi’s recent move to make changes in the valuation norms of liquid and ultra-short-term funds is a continuation of the efforts to reduce the systemic risk arising out of the swelling corpus of these short-term funds. There has been constant pressure on the capital market regulator to do away with the tax advantage the liquid and money market funds have over the bank fixed deposits.

Alok Singh, head, fixed income, Fortis Mutual Fund, said the changes in norms for debt funds, especially liquid and ultra-short-term funds, are meant to check the ever increasing size of the assets under management (AUM) of these funds, a major portion of which comes from companies, and to ensure that the fund houses do not run into trouble should there be any large-scale redemption pressure similar to what the mutual fund industry had witnessed in late 2008.

Singh said Sebi’s move to mark-to-market the value of securities with maturity up to 182 days would ensure the liquid and ultra-short-term funds are indeed liquid by allowing them to be valued in a more transparent manner.

At the end of December 2009, the assets under liquid funds and money market funds accounted for 70 per cent, or Rs 540,000 crore, of the total industry AUM of Rs 775,525 crore.

Mahendra Jajoo, head of fixed income, Tata Mutual Fund, said all the changes related to debt funds that Sebi has initiated are an effort to slowdown the large flow of institutional money into liquid funds. “Although in short run, these would lead to drop in AUM of the industry, in the longer term, these move would help stabilise the industry,” he said.