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Gilt and income funds – right time to start sip?


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Gilt and income funds – right time to start sip?

  1. 1. 1Mutual Fund Category Analysis November 29, 2011 Gilt and Income Funds – Right time to start SIP? Preamble: Long Term Debt Mutual fund categories, which have been underperformers in the recent past due to spiking yields, are likely to generate favorable returns going forward given the expectation that the interest rates in India will stabilize and then subside in the period of next few months. Inflation now and expected: Headline Inflation as measured by Wholesale Price Index, that has been trending at 9+ levels for ten consecutive months since December 2010, is expected to come off and touch 7% level in March 2012 as per the RBI’s expectation. The RBI’s continuous policy action of hiking rates coupled the expectation of cooling down of demand side pressure could likely to result in cooling off inflationary concerns by June 2012 (if not by March 2012). The Reserve Bank of India has increased the policy rates consecutively (13 times in 20 months with the cumulative increase of 525 bps) to tame the inflationary concerns. The recent hike of 25 bps each in Repo and Reverse Repo rates to 8.50% and 7.50% respectively by the RBI (during its monetary policy meet that held on 25th Oct 2011) could possibly be the last hike in the current interest rate cycle as hinted by the apex bank as inflation could start coming off from the current level of 9%+ by December. Apart from inflationary concerns and rate hikes, the factors such as heightened global uncertainties, sharp rupee depreciation, weak Govt finances, higher Govt borrowing, tight liquidity conditions and significant growth risks have been weighing the sentiment of the debt market. They have set the yields of the bonds at elevated level. Debt Mutual Funds schemes that have benefited so far: Debt mutual fund schemes that invest primarily in short term debt instruments have benefited and registered returns close to 8% on the back of higher rates at the shorter end of yield curve. Rates of short term money market instruments such as call, CBLO, T Bills, Certificates of Deposits and Commercial Papers have inched up to 9% level due to higher borrowing costs in the system. Tight liquidity condition in the wake of increased trade and fiscal deficit and less capital flow in the banking system has kept call and CBLO rates above 9%. Although there has been higher government borrowing, liquidity in the system is likely to be moderated (probably after the festive season) by the way of government spending, bond redemptions and the possible announcement of OMO operations.Gilt and Income Funds – Right time to start SIP? Retail Research
  2. 2. 2Mutual Fund Category Analysis contd… The government has recently raised the limit for foreign institutional investors participation in government debt which may enable further infusion of liquidity into the system. These rates are likely to witness downward trend going forward once the liquidity situation improves. Given the above facts, we are of the opinion that the yields at the mid and longer end of the curve could subside/fall going forward as the inflationary concerns start come off from the current level. When the yields drop down, the schemes that invest primarily in mid and long term debt securities will be benefited as the NAV of such schemes would move inversely with the yields. Thus, such debt schemes could provide better returns with a fall in yields on the mid and long end of the curve. The following chart displays the positive correlation between WPI, repo rates and 10 year bond yields. Repo Rate Vs. 10 Year Gilt Yield Vs. WPI Inflation: 12 10 10 Repo Rate (LHS) WPI (RHS) 10 Y (RHS) 9 8 8 6 7 4 6 2 5 0 4 -2 3 Jan-06 May-06 Jan-07 May-07 Jan-08 May-08 Jan-09 May-09 Jan-10 May-10 Jan-11 May-11 Sep-06 Sep-07 Sep-08 Sep-09 Sep-10 Sep-11Gilt and Income Funds – Right time to start SIP? Retail Research
  3. 3. 3Mutual Fund Category Analysis contd… The turmoil which the global economy experiences at present may not end in the near term as the countries have to strive hard to control the inflation, fiscal deficit and debt to GDP ratio. On the Indian front, concern on economic growth (given the fact that the slow down in the industrial activity would impact the growth rate of GDP) could apart from the inflationary concerns influence the RBI to pause hiking the interest rates. What happened in the past: Once interest rates start to drop, there could be the possibility of following the trend that happened in the past. The RBI had cut the Repo rate by 350 bps from 9% to 5.50% during the period 2008, starting from October 2008 to January 2009 (in four months), while the WPI inflation rate had started to trend down to below 4% from 9% level (see the above chart). Despite the current situation that prevails in the global as well as Indian economy is different from the 2008 crisis, one may assume that the RBI may cut the rates by 200 to 300 bps in next one year (not at the speed of 2008), given the expectation that the global uncertainties are likely to settle down in a year or so. Performance of MF debt categories in different periods: Note: All returns are compound annualized. The above table shows that the Gilt – Long Term and Income categories managed to generate better returns during the period between July 2008 and January 2009 where the 10 year benchmark bond yield witnessed a drop to 5.6% from 9.2% level. The Gilt – Medium & LT category appreciated most to 19% on compounded return basis while the value of income category increased by 11%.Gilt and Income Funds – Right time to start SIP? Retail Research
  4. 4. 4Mutual Fund Category Analysis contd… What should an investor do if he agrees with this expectation: Considering the above fact, investors may accumulate the units in the schemes from Gilt LT and Income categories by investing through Systematic investment Plan (SIP) for the period of next 3-6 months. The investment which is made in the actively managed schemes from the above mentioned categories could yield better return once the interest rates start to fall. Income funds take exposure to corporate papers of 2 to 5 years maturity, which appreciate fast in a falling interest scenario even as corporate bond spreads fall. This boosts their NAV in such a period. Investors will have to take an exit call at appropriate time, if his investments appreciate in line with expectations to reap full benefit. Recommended schemes from Gilt – LT and Income Categories: Note: Trailing Returns up to 1 year are absolute and over 1 year are CAGR. NAV/index values are as on Nov 28, 2011. ICICI Pru Gilt – Invest and Birla Sun Life Dynamic Bond Fund are the best performing schemes from Gilt Long Term and Income categories respectively. They registered CAGR returns of 34% and 16% respectively during the period between July 2008 and January 2009 where bond yields fell sharply close to 400 bps. Active call strategy helped those schemes to outperform during the period by allocating maximum assets on long dated debt papers. ICICI Pru Gilt – Invest and Birla Sun Life Dynamic Bond Fund held their assets with the average maturity of 113 months and 20 months respectively during the period.Gilt and Income Funds – Right time to start SIP? Retail Research
  5. 5. 5Mutual Fund Category Analysis contd… NAV growth of the schemes Vs. 10 Year Benchmark Yield: Rebased to 100. 180 ICICI Pru Gilt Fund - Inves Birla SL Dynam ic Bond 140 10 Yr Benchm ark 100 60 Jan-06 Apr-06 Oct-06 Jan-07 Apr-07 Oct-07 Jan-08 Apr-08 Oct-08 Jan-09 Apr-09 Oct-09 Jan-10 Apr-10 Oct-10 Jan-11 Apr-11 Oct-11 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 ICICI Pru Gilt – Invest: ICICI Pru Gilt – Invest is one of the outperforming schemes from Gilt Long Term category where it managed to generate 2%, 4% and 4% of CAGR returns over the last six month, one year and two year time frames. The category registered 2%, 4% and 4% for the periods while the benchmark I Sec Composite Index registered 2%, 5% and 5% respectively. (Trailing returns up to 1 year are absolute and over 1 year are CAGR). As far as portfolio is concerned, the scheme has allocated its maximum assets into 10 year benchmark gilt over the last one year period. The mean average maturity of the portfolio was at 73 months while the average modified duration was at 49 months. It seems to be the risky among peers as it generated Standard Deviation of 0.16% that calculated for last one year period (category SD was at 0.15%). No exit load is charged under this scheme. The corpus of the scheme as of Oct 2011 was at 221 crore. Gilt Long Term is the most exposed category to interest rate risk among debt categories where the NAV values of the category depreciate most during the rising interest rate scenario. Vice versa, the net assets of gilt LT schemes appreciate most while the interest rates are in southward trend.Gilt and Income Funds – Right time to start SIP? Retail Research
  6. 6. 6Mutual Fund Category Analysis contd…. Birla Sun Life Dynamic Bond: Birla Sun Life Dynamic Bond, a best performer from Income category, generated 5%, 8% and 7% of returns over the last six month, one year and two year time frames. The income category registered 4%, 7% and 6% for the periods while the benchmark Crisil Composite Bond Fund Index registered 4%, 6% and 5% respectively. (Trailing returns up to 1 year are absolute and over 1 year are CAGR). Given the leeway of dynamism of investing and churning its portfolio within any debt instruments with varying maturities, the scheme managed to generate decent return despite the prevailing situation of rising interest rates. The scheme increased its position in corporate debts from 34% to 53% over the last one year period while trimmed its exposure in Certificates of Deposit from 30% to 0.21%. This strategy clearly shows the fund manager’s expectation on drop in the rates. The mean average maturity of the scheme for last one year is as 20 months. There is an exit load of 0.5% on the scheme for the redemption within 180 days. The corpus of the scheme as per the latest data was at Rs. 2,347 crore. It’s a less risky one among peers as it registered SD of 0.05 for last one year period (category SD was at 0.06%). This scheme is suited for any kind of investors who want to have debt exposure on their portfolio given its investment strategy and past record. Analyst: Dhuraivel Gunasekaran. (Database sources: NAVIndia and Ace MF) HDFC Securities Limited, I Think Techno Campus, Bulding –B, ”Alpha”, Office Floor 8, Near Kanjurmarg Station, Opp. Crompton Greaves, Kanjurmarg (East), Mumbai 400 042 Phone (022) 30753400 Fax: (022) 30753435 Disclaimer: This document has been prepared by HDFC Securities Limited and is meant for sole use by the recipient and not for circulation. This document is not to be reported or copied or made available to others. It should not be considered to be taken as an offer to sell or a solicitation to buy any security. The information contained herein is from sources believed reliable. We do not represent that it is accurate or complete and it should not be relied upon as such. We may have from time to time positions or options on, and buy and sell securities referred to herein. We may from time to time solicit from, or perform investment banking, or other services for, any company mentioned in this document. This report is intended for Retail Clients only and not for any other category of clients, including, but not limited to, Institutional ClientsGilt and Income Funds – Right time to start SIP? Retail Research