THE global financial crisis coupled with the liquidity crunch in India has brought a sudden reversal in the fortunes of the mutual fund industry. Assets under management (AUM) in the funds business plunged to an 18-month low of Rs.4.02 trillion towards the end of November.

The mutual fund industry in India had seen remarkable growth in recent years. According to A.P. Kurian, chairman, Association of Mutual Funds in India (AMFI), the industry has been recording phenomenal growth rates of 50 per cent over the last three to four years.

AUMs peaked at almost Rs6 trillion towards the end of April. The following few months, however, saw a steady decline in assets, as the Indian stock markets also took a beating, with foreign institutional investors (FIIs) dumping billions of dollars worth of shares and repatriating funds back home to their cash-starved principals.

October was one of the worst months for the Indian mutual fund industry, with AUMs declining by almost a trillion rupees. The decline continued in November, though the fall was far less significant – about Rs300 billion worth of assets were liquidated by investors.

Kurian feels this could be the beginning of a slow recovery. “There is a change as liquidity has started to come back into the system and with that the funds have started flowing in particularly in liquid and liquid plus schemes,” explains the AMFI chief. “Today, redemption pressure has also drastically come down.

Things have changed positively, money has started coming in, and confidence is building up, so in non-equity side, there is no anxiety.”

About two-thirds of the corpus of the industry is in debt, while equity accounts for just a third of the AUMs. But the sharp fall in the stock market indices – the Sensex, the benchmark index on the Bombay Stock Exchange, declined by seven per cent in November alone – has destroyed billions of rupees in value for mutual fund investors. The result: investors are reluctant to put their money into the sector.

Kurian believes it might take a few more months for the trend to reverse and for investor sentiments to improve. Mutual fund AUMs are down by 27 per cent as compared to the year-ago figures.

Interestingly, according to AMFI, about Rs250 billion worth of redemption in September and October happened not because of investors dumping units, but as a result of redemption of various schemes, especially debt and money market funds.

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ALARMED over the massive withdrawals, both the Indian government and regulators, including the country’s central bank, the Reserve Bank of India (RBI), and the capital market watchdog, the Securities and Exchange Board of India (SEBI), initiated significant measures to ensure there were no panicky reactions.

The RBI, for instance, has cut both the cash reserve ratio and the statutory liquidity ratio – the portion of deposits that banks have to keep with the central bank or invest in government bonds – by 350 and 100 basis points respectively, ensuring additional liquidity into the economy of about Rs1.8 trillion.

The central bank opened a special 14-day repo window in October, allowing banks to raise up to Rs200 billion for lending to mutual funds and helping them tide over the liquidity crunch. State Bank of India, the country’s largest commercial bank, provided Rs50 billion in loans to mutual funds. A month later, a similar window was opened by the RBI for non-banking finance companies.

With corporates withdrawing money from fund houses – to meet their own requirements – there was a severe liquidity crisis in the mutual funds industry in October. The industry borrowed about Rs280 billion, but most of it has already been cleared.

Says Kurian: “In October, close to a trillion rupees had gone out of the industry, but there was no crisis. Not a single fund house refused redemptions – all redemption requests were honoured, except for two funds where they only staggered it. This is thanks to the liquidity facility provided by the Reserve Bank and the commercial banks.”

The asset quality of mutual funds is also good, with over 90 per cent being classified as top grade.

Last week, SEBI instructed mutual funds not to allow investors to exit from close-ended mutual funds before maturity. “All schemes will also have to be listed on the exchanges,” said C.B. Bhave, the SEBI chairman. Fund managers have also been asked to invest in instruments that match the maturity profile of the scheme.

According to Bhave, “from the October experience, we didn’t face any difficulty with regard to equity schemes even though the market had come off so much. We wouldn’t want to tinker unnecessarily with something unless an issue comes up. So just now the focus is more on what happens with debt schemes.”

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THE Indian government plans to allow profit-making public sector undertakings – especially the top-rated ones, which are classified as ‘Navratnas’ – to invest their surplus cash in mutual funds.

Government-owned firms are not allowed to invest their excess cash in mutual funds, but with the liquidity crisis continuing, the government wants to allow top-rated undertakings to invest in funds – though with a cap of 30 per cent of their total surplus funds. According to analysts, profitable government companies are sitting on cash adding up to Rs2.5 trillion.

AMFI wants these companies to invest in schemes being offered not just by public sector mutual funds, but even private ones.

But one state-owned firm that has been pumping in huge amounts into the mutual fund sector is Life Insurance Corporation of India (LIC), the largest life insurance company in the country. As per the rules, LIC has to invest 50 per cent of its corpus in government securities, 15 per cent in the infrastructure sector and the remaining in other instruments including equity, mutual funds, certificates of deposits and commercial paper.

LIC has so far injected Rs140 billion into the mutual fund sector, helping fund houses to tide over the crisis. Thomas Mathew, managing director, LIC, says many of the top funds approached the organisation, seeking investments. “Our investments in mutual funds remain within the regulations of the Insurance Regulatory and Development Authority (Irda),” he adds.

But according to observers, mutual funds will face a cash crunch once again over the coming months, as they face redemption pressure. Over the next four months, they would need nearly Rs370 billion as several fixed maturity plan (FMP) schemes mature during this time frame.

Fund houses are also being starved of liquidity as investors have virtually ignored the new fund offers (NFOs) in recent months. During the first six months of 2008, mutual funds raised over Rs200 billion through 26 NFOs. In the last five months (July to November), they could manage to raise a mere Rs3.5 billion through 14 NFOs, according to the AMFI. Last year, between July and November, mutual funds managed to raise about Rs165 billion through NFOs.

But investors continue to have trust in mutual funds managed by public sector financial institutions, such as UTI Mutual Fund, LIC Mutual Fund and SBI Mutual Fund. SBI Mutual Fund, which is controlled by SBI, raised Rs17 billion through an NFO recently. Some of the top private sector funds including HDFC, ICICI, Tata, Reliance and Birla Sun Life mutual funds are also attracting investors of late.

Despite the recent setback, industry expects to witness a revival once the liquidity position improves and investors start returning to the capital markets.