Run on mutual funds

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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