Mutual funds are launching liquid schemes and fixed maturity plans that bring together corporates with surplus money and banks willing to pay high rates on CDs in a tight money situation

The mutual fund industry, which is struggling to retain size, has found a new opportunity in certificates of deposit (CDs). Fund houses are now using an existing scheme (liquid plus) or creating fixed maturity plans (FMP) which will invest only in CDs.

Banks use CDs to borrow money from each other. It is transferable and has a secondary market. Ticket sizes for this instrument are very large and the tenure can be as short as 15 days or up to a couple of years. This enables them to give an 'indicative' yield (For, how the hell will SEBI find out when it is verbal?), without which a corporate investor will not park money. Of course, there are savvy corporates with large treasury operations, who invest in CDs directly with banks. But not all are savvy enough. Besides, going through a distributor is generally more rewarding at personal levels.
 
There are short-term CDs (of three months or so) which can earn 6-7% and one-year CDs which can give 9-10% per annum. Doesn't this sound juicy? Especially when bank deposits today earn barely 8% a year?

However, CDs are issued in lots of Rs25 crore and more. Corporates use such schemes to park their liquid surplus and opt for the 'dividend' option. This means that corporates get their full returns after payment of dividend distribution tax by the mutual fund. So everyone is happy. The fund house gets funds that boost its total corpus. The banker gets money to lend. The corporate investor gets good returns that are tax effective. The distributor gets his commission (anything from five paise for a liquid plus scheme to 35-40 paise for a FMP) and some of it may find its way back to the corporate entity or its employees through various routes.

'Indicative' yields range from 8.5% per annum for as short a period as a month, to over 9% per annum for 15 months. There are exit loads also, but if the corporate is savvy enough, it could negotiate with the distributor to ensure that the indicative yield is met.

While officially there are no guarantees, in the case of a difference between the indicative and actual yields, it is generally made good to key clients. This would be routed in different ways, but will ultimately come from the coffers of the asset management company (AMC), and only in rare cases from corporates or institutional distributors.

For the mutual fund industry, the season of CDs has come early this year. Typically, every year there is a spike in bank CDS around March. But this year, on account of the tight liquidity conditions in the financial system, banks have already started raising money from each other through CDs.
 
There will likely be opportunities for retail investors too, as some fund houses also accept amounts as small as Rs5 lakh. All in all, not a bad option at all.