Provident funds go for short-term debt

In the last six months, the yield on the 364-day treasury bill has risen by about 80 basis points to 7.80% and the spread between one- and 10-year government bonds has narrowed to about 25 basis points from about 120 basis points a year ago. Provident funds had nearly Rs1.50 trillion invested in domestic markets at the last count in March 2006, and traders say they have increased their t-bill buying at auctions in the past few months.

Deven Padhye, a director with provident fund advisory firm Darashaw & Co., said he did not expect funds to buy the longer-end aggressively until they saw interest rates touching a peak.

“Provident funds have gone excessively into short-term treasury bills, because they think the peak has not yet come," Padhye said.

The Reserve Bank of India has raised its key lending rate five times in under a year. The rate now stands at 7.75%, after it left it steady at its last review in April, but many in the market expect one more increase by the end of July.

Better yields

Employee provident fund (EPF), the government’s main saving plan for salaried employees, offered an interest rate of 8.5% in fiscal 2005-06, the last year for which a rate has been decided. The portfolio is made up of monthly contributions from both employees and employers. Close to 450,000 employers, both public and private, are members of the plan or have trusts governed by the EPF rules.

Provident funds are required to invest 25% of their portfolio in government bonds, 25% in bonds of state-run firms or bank deposits, 15% in bonds sold or guaranteed by Indian states and up to 5% in equity shares. The balance 30% can be invested either in government bonds, state paper or corporate debt. Within this limit, funds have the leeway to invest 10% in private sector bonds or equity mutual funds.

Analysts say provident funds are also parking large sums in bank deposits, which now fetch up to 10% for a one-year tenure, and buying bonds sold by state-run firms, which offer a higher return than sovereign bonds and are government-guaranteed.

There are restrictions on their investment. They are required to get permission from the government when they wish to sell securities, which hinders booking profits when bond prices rise.

Nonetheless, analysts say the higher returns offered on paper with short duration should help profits this calendar year, especially as reinvestment risk at the short end is lower while the yield curve is relatively flat.

“I expect provident fund returns to be significantly better. Further, PFs have also deployed in fixed deposits with banks at double-digit rates," S.P. Prabhu, head of trading at IDBI Capital, said.

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