Run on mutual funds

Indonesia-based investors, the Capital Market Supervisory Agency (Bapepam) and mutual fund managers have seemingly not been able to learn from the massive runs on mutual funds in late 2003 and in April this year that caused unnecessary losses to investors and disrepute to the funds industry.

The funds industry encountered another wave of panic redemption earlier this month, losing out almost Rp 40 trillion (US$4 billion) in just a few days as jittery investors rushed to redeem their fixed-income mutual funds at lower values and moved their investments to time deposits -- which now offer higher returns -- or shifted to dollar positions.

The main cause of the massive redemption is the same factor that set off the previous runs: Investors became greatly concerned after observing the net market value of their funds declining steadily as the central bank tightened its monetary stance to defend the rupiah and cope with strong inflationary pressures.

Actually, it is simply natural for investors to shift from one investment instrument to another to gain higher returns. Since fixed-income mutual funds are priced on the basis of the prevailing market value of their underlying assets (mostly bonds), their prices fluctuate according to the market prices of government bonds. Because the central bank moved faster to raise its benchmark interest rate from 8.50 to 10 percent over the past three weeks, the prices of government bonds and consequently the value of fixed-income mutual funds also declined significantly.

But what turned the otherwise natural market development into a massive run was investors' confusion over the pricing of their fixed-income mutual funds. Many investors assumed that since they invested in fixed-income mutual funds the net asset value of their funds also should be stable. They apparently have not been adequately educated by funds managers to understand that each mutual fund share (unit) will represent the value of the securities (bonds) held in portfolio and therefore is exposed to price fluctuations.

The complaints raised by many of the panicky investors who rushed to redeem their funds last week showed that mutual-funds marketing agents still often resorted to misrepresentation, misleading potential investors to believe that, like time- deposits at banks, fixed-income mutual funds generate fairly stable rates of return.

Though part of the blame should be put on misguided investors, we also wonder what happened to the standard repurchase agreement Bapepam set up a few months ago. This facility should have been able to prevent mutual fund managers from dumping their securities at fire sale prices to raise funds to reimburse their investors, because the agreement stipulates a provision that they can buy back their investment for specific prices by specific dates.

The central bank and the finance ministry did help prevent a worsening of the condition last week by entering the secondary market to buy a portion of the bonds dumped by mutual fund mangers desperate for cash to refund their investors.

However, without an effective market instrument as the standard repurchase agreement, mutual fund managers may again have to dump their securities to meet panic redemption by jittery investors because, unlike commercial banks, they do not have a central bank to rely on in case of such a rush.

Since the prices of government bonds will likely continue to decline as the central bank will steadily raise its benchmark interest rate to counter inflationary pressures caused by the upcoming fuel price hikes, the market value of mutual-funds also will likely stay on a downward trend until next year.

Bapepam recently issued directives on a new fund instrument called protected capital mutual funds, which guarantees investors at least the nominal amount of their initial investment, thereby protecting them from price fluctuations. But this new instrument also is appropriate only for long-term investors -- not the ones who are skittish about price fluctuations -- because the guarantee is effective only at the date of redemption of the funds.

Massive funds redemption and unnecessary losses can be prevented if investors are fully enlightened on the benefits and risks of mutual funds as a long-term investment vehicle. Investors must realize that mutual funds are basically a long- term investment, which, like other investment instruments, has its own risks of price fluctuations. Mutual funds are not a banking product and are threfore not covered by the government blanket guarantee on bank deposits and claims.

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