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Rolling settlement and worried funds

Aabhas Pandya

Rattled equity funds have yet another problem on their hands. With rolling settlement likely to hamper liquidity - at least in the short-term - fund managers are hiking investments in more liquid stocks. The problem could be acute in funds with a pre-dominantly mid-cap orientation. Already, traded volumes have come down sharply with the ban on short sales. Liquid investments are important for funds since they need to sell instantly under redemption pressure with minimum impact cost.

Come July 2, rolling settlement will take off in 414 stocks, including the most active A group, which roughly account for over 90 per cent of the total volumes on the bourses. Under rolling settlement, trades will have to be compulsorily settled on the fifth day with ban on deferral products. With speculators at bay, this will suck out liquidity. Further, plans are afoot to introduce stock options, where liquidity is the key since options will be traded in more liquid counters. On the other hand, the crash in equities since early 2000 has come as a blessing in disguise with most funds buying into actively traded stocks in a bearish market.

"Volumes will certainly take a dip for 3-6 months since investors are not familiar with trading in rolling settlement. Thus, it is important to stay invested in more liquid stocks, which provide good volumes post July 2," says Aniket Inamdar, fund manager, Chola Freedom Technology. In fact, liquidity is also not homogeneous in A group, where a handful of stocks contribute most of the volume. Further, shareholding pattern is the key, for the stock may belong to a top-rated company but may have a low floating stock.

It could be a tough task ahead for funds with primarily mid-cap holdings. The problem for mid-rung stocks is compounded by the fact that even top quality stocks with large capitalisation are today available at similar valuations.

The Value Research category of equity funds has as many as 14 schemes, where mid and small-cap stocks account for over 50 per cent of the portfolio. Although a relative term, mid and small-cap stocks typically have a capitalisation of less than Rs 1000 crore. "We continue our efforts to exit from relatively illiquid small and mid-cap companies in the portfolio," says Divya Krishnan, CIO, SBI Mutual Fund. The illiquidity due to the ban on short sales already caused a collapse in stock prices of some of the asset management company's medium-cap holdings in April.

Or, take for instance, Kothari Pioneer's Prima Fund that invests in a mix of mid and small cap stocks. "The recent Sebi decision to move stocks in rolling settlement will affect the volumes of mid-cap stocks. In order to maintain liquidity, we are churning our portfolio by shifting towards top stocks in the mid-cap category. We can also invest a small part in large-cap stocks and plan to use it," says fund manager, K N Siva Subramanian. "With hardly any retail participation, volumes have dropped to 25,000 to 50,000 shares in most mid-cap stocks,'' he adds. KP Prima is now hunting for stocks, where market cap is closer to Rs 1,000 crore with high dividend yield.

While the rolling mode will have a negative impact in the short-term, fund managers believe it will be temporary and volumes will eventually grow. "The new system will benefit investors in the long-run and they will, in some time, start to trade in the rolling mode and quality stocks will continue to attract sustained trading interest. Similar doubts were raised when dematerialisation came into effect but eventually, it was a smooth transition," E A Sundaram at Zurich India AMC strikes an optimistic note.

But for now, fund managers are keeping their fingers crossed while actively churning their portfolios.

Source: Value Research

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