Mumbai: Investors who have ploughed money into mutual funds while stocks were rising may rush to withdraw when stocks fall, putting severe redemption pressures on fund houses, a top official at the stock market regulator said.

“Redemption gating, suspension of redemption, redemption fees, (and) side pockets and liquidity (outflow) will hit us on the head once the markets start turning around. At the height of euphoria, when the markets are up is the best time when we can plan out these. If there is a huge amount of redemption pressure in the wake of markets falling, the industry needs to think of leverage ratio, (and) liquidity ratio… We just can’t run away from it,” G. Mahalingam, whole-time member at Securities and Exchange Board of India (Sebi) said.

Redemption gate refers to temporary suspension of a shareholder’s right to redeem shares of the fund. A side pocket is used by fund managers to separate stressed or risky assets from other investments and cash holdings. Fund houses create side pockets to ensure that while a proportion of investor money (in the scheme) linked to stressed assets gets locked in until the fund recovers dues from a stressed company, investors are free to redeem the rest of their money if they choose to.

“We need to keep in mind that a huge amount of gushing liquidity is keeping us afloat and once this liquidity gets withdrawn, it will be interesting to see how the mutual fund industry behaves. For sustainability, it will be imperative to note how the industry will behave when SIP flows or retail money falls,” Mahalingam said at the 12th edition of the CII Mutual Fund Summit in Mumbai.

Mutual funds currently have about 18 million systematic investment plan (SIP) accounts, through which investors regularly invest in schemes. According to Association of Mutual Funds in India (AMFI) the total amount collected through SIP in November was Rs5,893 crore.

Despite lofty valuations and a slowdown in earnings, this rush of money has driven stocks to record highs this year. However, Mahalingam cautioned there could be an outflow from India if the US Federal Reserve starts raising its benchmark interest rates.

“The Fed is expected to hike interest rates up to 75 basis points (bps) in 2018 and if real interest rates are bought down in India, then fund flows may take a reverse direction,” he added.

The US Federal Reserve is widely expected to increase key interest rates after its two-day Federal Open Market Committee (FOMC) meet that ends on 13 December. The central bank has already hiked rates twice this year.

Foreign institutional investors (FIIs) have bought Indian shares worth $8.21 billion in 2017 while domestic institutional investors (DII) including mutual funds and insurance firms have pumped in Rs86,629.03 crore in Indian equities so far this year. The benchmark indices Sensex and Nifty have rallied around 25% this year compared to a rise of 12.54% of MSCI World and while MSCI EM jumped 22.99% in the same period.

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