The gilt trip

The gilt trip
Comment E-mail Print Share
First Published: Wed, Feb 04 2009. 12 00 AM IST

Updated: Wed, Feb 04 2009. 12 00 AM IST
If you are still smarting under the shock of losing much of your money after investing in fixed maturity plans (FMPs), you will do well not to shun all debt funds. In fact, there are two debt fund categories vying for your attention: gilt and income funds (medium- and long-term debt funds). Gilt funds (which invest in long-term government paper) delivered impressively last year. As on 10 December, these delivered an annual return of 16.53%, second only to the Gold ETF category.
Once interest rates began to ease, the yield of 10-year government of India (GoI) securities declined sharply. This led to a net gain of 13.13% between 14 July and 10 December. But whether these funds can post similar high returns in 2009 is anybody’s guess. However, your decision to consider an investment in gilt funds would depend largely on whether the yields of G-Secs continue to decline.
On the other hand, we have debt funds, which seem to be the best bet in the current macroeconomic scenario. On 24 November, ICICI Prudential Mutual Fund sent a note advocating debt funds, keeping in mind the current economic environment. According to it, the 10-year AAA rated corporate bond spread was at a very high level.
On 29 July 2005, the spread between 10-year gilts and AAA-rated corporate bonds was 58 basis points (bps). It rose to 138 bps on 11 July and 396 bps on 21 November.
Now, in a falling interest rate scenario, the fund house expects the spreads of higher-rated PSU bonds and corporate bonds to decline. According to it, income funds provide an excellent opportunity to capture this trend.
We spoke to four fixed income fund managers and asked them if investing in gilt or income funds would be a good idea. They seemed pretty unanimous on the fact that it would be unwise for investors to park their money solely in gilt funds. Rather, they suggested income funds that invest in both gilts and bonds.
Birla Sun Life Mutual Fund
The broad direction for the interest rate is downwards. Commodity prices coming down not only help bring down inflation but also the overall fiscal situation due to less issuance or, rather, no issuance of oil bonds and fertilizer bonds as part of the government subsidies. The negative outlook on the overall growth in the Indian economy in particular and the global economy in general essentially will ensure that the policy environment for interest rate(s) will remain benign. One should not be surprised if the 10-year benchmark touches its earlier low of 2003 with such developments.
But investors should look at a combination of gilts and corporate bonds. Income funds take interest rate calls by investing in both. During the period of credit crisis globally and domestically, credit spreads for corporates have gone up beyond the historic high level, reflecting (an) extreme level of pessimism on the credit market. However, this might change for the better on the back of falling inflation and RBI action in terms of providing liquidity as well as lowering interest rate.
I expect income funds to outperform gilt funds though credit risk remains in income funds which is otherwise absent in gilt funds.
Head, fixed income
Canara Robeco Mutual Fund
In the near term, we expect G-Secs yields to drop by 25 bps (against closing on 8 December). The 10-year G-Sec yield could top at 6.40%. Fresh borrowings by the government reduce the chances of the yield dropping below this.
Gilt funds could provide opportunities arising out of volatility in trading. But there is no significant upside left for capital gains. Income funds are better placed than gilt funds for 2009. Corporate bond spreads over sovereign yield are at 350 bps.
These spreads have to reduce going forward. So, income funds would capture the fall in the yield curve itself and also the opportunity of further spread reduction.
Also, the carry yields in income funds provide a cushion for any downward pressure arising out of the strengthening of the yield curve or volatility.
Head, fixed income
Bharti AXA Investment Managers
Over the next three to four months, the rupee is likely to remain under pressure till the dollar squeeze continues and the global credit crunch stabilizes. The pace of depreciation is expected to slow down, with the RBI showing its intent by supporting the rupee at crucial levels.
The panacea during such periods is fiscal and monetary stimulus for the economy. In our case, the allowances for fiscal measures are limited. So the central bank will have to resort to monetary measures. With inflation under control and growth faltering, RBI will continue to cut key interest rates. In the next year we expect RBI to cut the reverse repo by 100-150 bps.
We are in a scenario where interest rates are going to head southwards. During this time period, investors in income funds with decent interest rate durations can look forward to capital appreciation due to falling interest rates.
CIO, fixed income
JPMorgan Mutual Fund
Yields on government bonds will drop further as inflation drops further. A global slowdown and a slow domestic economic recovery should be supportive of the bond markets.
If investors want to invest in gilt funds, they should do so with a 12-month perspective. But we think an actively managed bond fund with the ability to switch between corporate bonds and gilts will perform better than a gilt fund, per se. This is because the bond funds will benefit from corporate spread compression as well as the lower interest rate scenario.
Why interest rates may fall
Global central banks have been cutting interest rates in order to ward off recession. Their main focus now is on pumping liquidity into the system to revive their respective economies. India is no exception. Given the concerns on a global slowdown, commodity prices are likely to remain subdued and moderate over the coming months. In India, inflation has been easing and economic growth is slowing. GDP growth forecasts have fallen from the earlier estimates of 8-9% and now vary between 6% and 8%.
RBI has changed its stance to a growth bias and the central bank is looking at easing liquidity conditions and enhancing credit flows. Between April and September, RBI delivered 150 basis points (bps) of cash reserve ratio (CRR) hikes and 125 bps of repo rate hikes (CRR is the level of cash that commercial banks are required to keep with RBI; repo rate is the rate at which RBI injects liquidity into the system). The tight monetary policy, coupled with global turmoil, had started affecting the economy adversely by leading to a tightening of credit conditions and high interest costs.
In October, RBI cut the CRR by 350 bps and the repo rate by 150 bps. On 6 December, RBI reduced the repo rate by 100 bps from 7.5% to 6.5% and the reverse repo rate (the rate at which RBI sucks liquidity from the system) by 100 bps from 6% to 5% (effective 8 December). This has set the stage for falling interest rates.
In December, the MF industry’s assets under management (AUM) increased by 4.73%. The industry witnessed an inflow of Rs19,069.45 crore during the month. Reliance Mutual Fund maintained its top position with an AUM of Rs70,208.10 crore, which is a third more than its second closest competitor HDFC Mutual Fund, which manages around Rs46,757.45 crore. While two fund houses reported an increase in their AUMs in November, 16 fund houses saw an upsurge in their AUMs in December.
Fidelity Fund Management has increased the entry load for all its equity funds effective 1 January. It has been hiked to 3% from 2.25%. The load will be applicable only to investments below Rs5 crore for its five equity funds—Fidelity Equity, Fidelity India Growth, Fidelity India Special Situations, Fidelity International Opportunities and Fidelity Tax Advantage. Most Indian equity funds charge an entry load of 2.25%. Besides Fidelity, 21 of 342 open-end equity funds charge an entry load of at least 2.25%. These are mainly funds which invest abroad.
Even as the magnitude of the fraud around Satyam Computer Services is unravelling slowly, what is surprising is that even the mutual funds did not smell anything fishy. When we looked at the 10 schemes with the maximum number of Satyam shares, four from HDFC MF and three from Sundaram BNP Paribas MF featured in the list. Four schemes, including the five-star rated ones Sundaram BNP Paribas Taxsaver and HDFC Prudence, did not have any exposure to the Satyam stocks in November. They actually entered the stock in December.
The Sensex gained 9.13% in December and equity funds churned their large cap positions but overall, they bought stocks worth Rs1,064 crore in December. State Bank was the top purchase across all equity funds in December as 16 funds added to their portfolios. State Bank gained 22% in December. Reliance Equity and DSP BlackRock’s four equity funds— DSPBR Top 100 Equity, DSPBR Small & Mid Cap, DSPBR Equity Fund and DSPBR TIGER Fund—fancied State Bank most.
Comment E-mail Print Share
First Published: Wed, Feb 04 2009. 12 00 AM IST