For some time now the yield curve across tenors has seen a visible upward shift leading to lucrative investment opportunities across various segments. Depending on one’s risk appetite and investment horizon there are options which could be looked at within the fixed income product suite.
This note focuses on the current trends in the fixed income market, guidance going forward and how funds of different duration make sense at this juncture
Factors driving yields:
Here we are talking about Gsec yields or treasury yields as some may call it as they are always the lead indicator and the benchmark for rest of the yields in the country.
Fiscal Deficit:
Our economy is in such a phase currently that Fiscal deficit is no longer frowned upon. The media lately have stopped showing concern over our seemingly high fiscal and current account deficit. The fact is world over with exception of a few countries the fiscal deficit is at their all time highs. Governments across the world are spending and fiscal deficit is least of their concerns or that is what they portray.
But bond traders are not going to close their eyes just because the media has stopped printing news. They are ever aware about the latest happenings in government borrowing as well as spending. It is they who decided the yields that need to be charged for every government borrowing. The more your deficit obviously the more you gonna get charged for the loan you take. The more your debt lesser is your credit quality. So these are some of the main principles in determining government borrowing yield.
For the current year the budget Deficit was 5.5% of GDP but in all probabilities it could be revised downwards towards the end of the year (the government has already cancelled auction worth INR 100 bn) and the trend may continue next year as well. Prime drivers for reduction in fiscal deficit are: robust collection thru auction of Broadband and 3G Services (significantly higher than estimates ₹100,000Cr), healthy tax collection, Disinvestment (estimated collection ₹50,000Cr) and de regulation of petrol prices.
Government has successfully completed the 1st half Borrowing programme i.e around 60% of the total borrowing estimates. For the 2nd half, the supply is relatively less. Towards the end of the year potential demand form terminal benefit funds could boost the overall demand for Government bonds. Overall, this bodes well for long term interest rates
Liquidity:
Liquidity is the key driver of markets for me liquidity is that animal which is hard to predict as well as tame. When more money is there in your hands like a performance bonus or hike in salary, you usually spend it. Same way when the entire system is flush with funds which includes banks, public and other institutions what do all of them tend to do, they all spend. When they all spend it creates an inflationary trend which is rise prices.
What has this got to do with Yield the more liquidity in the system lesser the yields and tighter the liquidity situation gets higher the yields though the relation is not that simple as it sounds it more or less always behaves in this fashion.
Banking system is going through liquidity crunch and the banking system has been borrowing on an average around 60,000 core on a daily basis. This situation is likely to continue for some time now as the system also sees the launch of a huge IPO which is already sucked around ₹200,000Cr. Also the festive periods leads to huge rise in the currency circulation with the general public, which also aggravates the tight liquidity situation with banks. Less lmoney in the hands of banks lesser their inclination or capability to buy Gsec papers/bond and hence higher yields.
However, the degree of tightness is likely to ease when 1) The IPO closes and the rest of the money is given back by Coal India as Coal India requires only ₹15,000Cr. 2) As and when the government spending starts or the RBI intervenes in the forex markets to stem the excess volatility in the forex market. But the key driver of liquidity coming back would be government spending as the RBI normally sterilizes the liquidity injected through intervention.
Inflation:
Wholesale Price Inflation (WPI) has shown signs of easing largely because of new WPI series i.e from high double digit to 8.5%. The driver of inflation has been supply and largely attributed to Primary articles/ Food price/ fuel price inflation which is normally outside the control of the RBI.
However as there were signs of the inflation being generalized and therefore becoming a threat to the price stability The RBI has already taken stringent measures to normalize monetary policy by hiking interest rates/ CRR and in turn removing liquidity overhang which is usually inflationary in nature and usually leads to asset price bubble. So they plan to curb liquidity and when they do that rates yield usually rise. Going forward the RBI expects to curtail inflation (WPI) by around 6% and target date for this is march 2011.
Monetary Policy Stance:
RBI has been raising Reverse Repo and Repo rates for the following reasons:
Partly normalization, i.e. exiting from the expansionary/loose monetary policy in the crisis period which started in Sep 2008. The RBI in the mid-qtr review has made it clear that the normalization process is largely over and future course of action will be decided by the incremental data going forward. i.e IIP/WPI etc.
To manage inflationary expectations
The latest reading on IIP has been a modest 5.6% (against expectation of 9.5%). Inflation remains sticky, but is off the double digit numbers seen. Liquidity continues to be in deficit mode for now. Additionally, developments on the global front are far from being healthy, pointing at further monetary easing in countries like US, UK and Euro zone
For the Inquisitive Investor
I think playing the debt markets is a very tricky thing. You need to be very careful of the nuances involved in debt markets. For me debt markets are 10 times more unpredictable than equity markets. Another thing to be noted is when yields go up your debt fund NAV does not go up like your Equity Fund NAV. When markets go up or the stock price goes up Equity Fund NAV goes up. In debt funds when the yield goes up the NAV of the fund does not go up it actually goes down it works reverse. For the debt fund NAV to go up the yield should come down. Will explain about this concept on a later post for the time being just understand that Fund NAV and Yield are inversely correlated keeping other factors constant.
Not over yet; another concept in debt funds is Average Maturity or tenor of the fund. Every debt fund buys bond papers like a equity fund buys stocks a bond fund buys bonds or commercial papers. The maturities of these papers vary example SBI comes out with a 10 year bond the maturity of the bond is 10 years. When shriram transport comes out with a 2 year bond deposit then the maturity of the paper is 2 years. Assuming a debt fund buys 1 bond of SBI and 1 bond of Shriram Transport, then the Average Maturity works to around (10 years+2years)/2 bonds = 6 years. The average maturity is around 6 years. Same way debt funds calculate average maturities of their funds, some funds will have average maturities 1 month and some funds will have average maturity of 30 years. In debt funds higher the maturity or greater the maturity the more risky the fund gets. Lesser the maturity lesser the risk.
Coming back to the recommendation
Debt funds should be looked as a safe investment heaven with absolutely no capital erosion. Debt funds also loose capital because it works on the Principal of NAV. Higher the NAV goes higher your returns, if your NAV falls due to any reason or when the yield goes up then u make a loss. Because of this reason I usually prefer to hold debt funds for my client in the 1month to 6 month maturity horizon. The funds in this category are called Ultra Short Term funds. They offer liquidity as well as chances of capital erosion are very slim. I don’t take any risk in longer duration funds as my policy is take all the risk were you can understand the risk factors and predictability is better. So I take my risk in equity and in debt I am absolutely safe because that is what debt is there for.
For the risk taking Investor I would suggest enter into funds of Kotak Gilt Fund, Canara Robeco Gilt Fund, Birla Gilt Fund, HDFC Gilt Fund and ICICI Gilt fund all long term option and all of them have average maturity between 8-12 years. the reason for entry is I feel the yield have gone up significantly because Coal India has taken out a lot of money from the banking channel amounts to ₹200,000Cr and the company actually requires only ₹15,000Cr, so when the unsubscribed money hits the market the excess liquidity will bring down yields thereby increasing NAV of the Gilt Funds I mentioned.
Clients entering now into Gilt funds can expect to make on an annualized basis anywhere between 11-26%on gilt funds in another 6 months.
Coal India Share Price
ReplyDelete