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Are gilt funds losing their shine?

Are gilt funds losing their shine?
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First Published: Sun, Apr 26 2009. 11 37 PM IST

Updated: Sun, Apr 26 2009. 11 37 PM IST
With their resurgent performance in 2008, gilt funds, like gold, scored very high on investor preference. Last year, at a time when the equity class was logging negative returns, gilt funds delivered a handsome 25.33% return.
Initially, in 2008, gilts were habitual non-performers, or chalked up nothing spectacular. Not much was expected of them either. This changed only when the Reserve Bank of India (RBI), in an effort to combat the liquidity crisis, announced a series of rapid cuts in repo rate (the rate at which RBI injects liquidity into the system) between October and December.
This had a dramatic influence on gilts. With a cut of 2.5 percentage points in repo rate and a cut of 3.5 percentage points in cash reserve ratio (the proportion of deposits that commercial lenders in India must keep with the central bank as cash), gilt funds’ returns shot through the roof. This overperformance was mainly due to the 20.69% returns registered during the last quarter, in particular the 12.43% gain logged from just the month of December.
To understand the reason behind this sudden resurgence of gilt funds, we have to understand what they are. Simply put, gilts are mutual funds that predominantly invest in government securities or G-secs—securities issued by RBI on behalf of the government. Unlike conventional debt funds that invest in debt instruments across the board, gilt funds target just a given category of debt instruments (G-secs).
Being sovereign paper, they do not expose investors to credit risk. They are also the most heavily-traded paper in the market. Entities such as banks, insurance companies and provident funds invest in them for safety and statutory reasons. This also ensures adequate liquidity and, in turn, volatility for G-secs in the market.
Gilt funds assets almost doubled from Rs2,500 crore in November to Rs4,800 crore at the end of February. However, things changed again as falling inflation numbers and increasing uncertainty in the economy forced RBI to announce a repo rate cut by 50 basis points (bps or one-hundredth of a percentage point) on 4 March. But to the dismay of many, the yields refused to budge in response. The gains expected by investors were nowhere to be seen. The reason for this was the government’s ongoing borrowing programme.
Anticipation of a flood of new bonds has kept market players at bay. The result is that the yield is going up rather than falling. Since the beginning of the year, the yield has hovered on an average above 6.30%. Ideally, a 10-year benchmark yield should be trading near 5%, considering the rate cuts that have happened till date. The rate cut of 25 bps announced in the annual review held on 21 April is in line with this. As a result, going by the trend in the G-sec market, 2009 has not been a very exciting year for gilts as the category is down by 7.16%.
Looking at the month-on-month return of gilt funds, it may seem that these have become too risky an investment option. But the fact is, this is how gilt funds have always been. In 2001 and 2002, when interest rates were coming down, gilt funds were the prime beneficiaries.
Their returns were comparable with equity fund returns, but the moment there is a long period of inactivity on interest rates or if rates are on an upward trend, gilt funds become a very dull investment option.
We think interest rate movements will remain chaotic, more so considering the current crisis. At times, interest rates may be predictable, but their impact on bond prices may hold surprises—both have happened in the recent past.
Gilt fund managers are often guilty of doing too much. There are plenty of funds that increase or decrease maturity violently at the slightest sign—real or imagined—of rate movements. A gilt fund manager’s job is to take calls on rates and yields but that doesn’t mean a call has to be taken all the time.
Nor does it mean that maturity must always be jerked from one extreme to the other whenever a call is taken. In these unpredictable times, a path of circumspection and moderation is what can take best care of investors interests.
Keeping this in mind, we have selected three funds that are not the top performers of the past few months, nor are they the biggest. However, we believe they fit the above profile well and can be looked upon favourably by investors.
However, it is important to keep in mind that notwithstanding the credit quality, medium- and long-term gilt funds are the most unpredictable animals in the fixed-income zoo. Invest at least for a year and be prepared for short-term shocks.
Canara Robeco Gilt PGS: Steady as a rock
Over the last few years, Canara Robeco Gilt PGS has established itself as one of the steadier performers in this category. In the five years since 2004, it has more than kept pace with its peers, either outperforming the average gilt fund handsomely or lagging by a small margin. In all, Rs1 lakh invested in this fund would be Rs1.47 lakh today as against Rs1.34 lakh for the average gilt fund. In fixed-income terms, that’s a fair difference.
Also See Canara Robeco Gilt PGS (PDF)
During 2008, the fund’s returns were an astounding 35.17%, which put it in sixth place. However, what impressed us more was the fund’s progression through what was an exceptionally turbulent year. During the first three quarters, the fund was ahead of the category average by an average of 2.64% every quarter, adding up to a cumulative lead of 7.92%. In the last quarter, it exploited RBI’s interest rate bonanza as well as the rest, with returns of 20.63% for those three months. However, the fact that the fund matched the average and did not do as well as the top funds during the quarter looks like a positive sign to us.
When we observe the maturity changes that fund manager Ritesh Jain affected during that phase, we see a degree of conservatism which we like. During the October liquidity crisis, the fund manager dropped the maturity. When RBI unexpectedly softened rates in November, the fund gained less than its peers. Investors shouldn’t mind this because dropping yields during the global liquidity crisis was a safer course of action. The point is proven when we look at how things played out in 2009.
Its lower maturity has helped in containing the downside well in January and February. It was down by 3.01% and 0.76% while the category was down by 6.23% and 1.74% (January and February) respectively.
ICICI Prudential Gilt Investment PF: High roller
Make no mistake, this is an aggressive fund. While 2008 was a great year for practically all gilt funds, this fund was shining much brighter than the others. During the year, its returns were 45.44%, much higher than the average of 24.94%.
Also See ICICI Prudential Gilt Investment PF (PDF)
The returns were a result of a characteristically nimble action on the maturity front. When the yield came down from 9.33% (July) to 8.67% (August), the fund increased its maturity profile from nine months to 12 years. As interest rates kept falling further, the fund manager increased maturity further to 18.16 years by end December. At that point, the average maturity of the other funds of the category was 13.70 years. This gap is what produced the fund’s good performance.
However, the next two months showed investors the flip side of the approach. In January and February, the fund manager expected interest rates to go down further and increased the average maturity to 20.19 years (February) while its peers reduced it to 10.82 years. However, when the yield moved up from 5.25% (December) to 6.40% (February), the fund lost money. Commendably, its losses in January and February were in line with the category average (-6.63% vs -6.23% and -2.07% vs -1.74%).
During January and February, the fund held a rank of 18 out of 47 funds in the category. Because the fund exploited 2008 so well, it was very much top of the heap over the entire period (January 2008 to February 2009). Over a longer term too, this is an outperformer. Since its launch in November 2003, there has never been a year when its returns were less than the category average.
Our conclusion: This is a smartly-run fund, albeit an aggressive one. If this is the profile you are looking for then ICICI PRU GILT Investment PF is a good choice.
Templeton India GSF Long-term: Controlled aggression
Templeton IGSF Long-term is a gilt fund that has managed to implement a remarkably balanced approach. It has never raced ahead but has never suffered a severe reversal either. In the seven years since it was launched, its annual returns have always been ahead of the category average. Also, they’ve always been positive—even in 2004, when the going was tough and the category as a whole lost money (-0.40 %), this fund made a reasonable gain of 2.95%.
Also See Templeton India GSF Long-term (PDF)
The most interesting fact about this fund’s performance history is that it has done well during both rising and falling interest rate regimes. Between February and July, the yield of the 10-year benchmark paper rose from 7.56% to 9.33%, the fund generated on an average 0.20% return monthly while the category was down with a negative 0.19% return. In January, when the yield rose to 6.21%, the fund was down by 0.35% while its category was down 6.23%. The average maturity of the fund was 7.61 years while the category’s was 12.54 years.
During this period (June), Vivek Ahuja replaced Ninad Deshpande as the fund manager. In its seven years, this fund has reported a maturity less than its stated three years for 13 months. This has helped it handle rising interest rate situations better than many others. The conservative attitude has also meant that the fund exploited the 2008 Q4 bonanza less effectively than category leaders. However, returns for 2008 were still a solid 27.65%, well ahead of the category’s 24.94%.
For investors who would like to balance caution and aggression, Templeton IGSF Long-Term is ideally suited for trying out the occasionally troublesome category of gilt funds. It manages to deliver the better aspects of gilts while filtering out the worst.
At a time when everything seems to be going down, fixed maturity plans (FMPs) seem to have recorded a resurgence of sorts in March, with the launch of 25 new products.
The last few months have been whirlwind times for FMPs, which have been a popular asset class because of their tax efficiency and predictable returns. They accounted for 22% and 17% of the mutual fund industry’s total assets in October and December respectively. However, October’s liquidity crisis affected them severely and in February, their shares dwindled to 13%.
Real estate stocks are in the news once again. Fund managers are looking at the very stocks that burnt their fingers last year. In January, the number of schemes invested in real estate stocks came down to just 78 and the invested amount, to Rs74.77 crore. Mutual fund assets invested in real estate stocks are now Rs121.4 crore (as of March) and the number of schemes invested in such stocks is 102. In March, Kotak Equity Arbitrage, Taurus Bonanza, Taurus Discovery and Taurus Taxshield bought the stock.
Real estate stocks are in the news once again. Fund managers are looking at the very stocks that burnt their fingers last year. In January, the number of schemes invested in real estate stocks came down to just 78 and the invested amount, to Rs74.77 crore.
Mutual fund assets invested in real estate stocks are now Rs121.4 crore (as of March) and the number of schemes invested in such stocks is 102. In March, Kotak Equity Arbitrage, Taurus Bonanza, Taurus Discovery and Taurus Taxshield bought the stock.
Monthly income plans have not escaped the carnage in the equity markets, despite their exposure to equities being limited to a maximum of 30%. In 2008, these funds posted their first annual decline. And for the 15-month period ended 31 March, it had an average negative return of around 3%.
The name could be misleading. These funds are not obliged to pay a monthly dividend. But they do attempt to pay dividends frequently in a calendar year, if not monthly. However, over the past year, they have found it very difficult to stick to their objective in spirit.
How did Wockhardt Ltd get into a debt crisis when it had a great run from 2000 to 2007, with a compound annual growth rate of 10.46%? The answer lies in ambitious overseas acquisitions during this period. The firm borrowed heavily and is now faced with a mounting debt of approximately Rs3,400 crore. By end September, it has to repay the $108 million (Rs700 crore) of the foreign currency convertible bond (FCCB) loan it availed. Meanwhile, State Bank of India has sanctioned a lifeline loan of Rs100 crore to help the pharma major meet its working capital requirements.
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First Published: Sun, Apr 26 2009. 11 37 PM IST
More Topics: Gilt Funds | Gold | RBI | Banks | Insurance companies |