Wednesday, July 27, 2011

Arbitrage funds take debt route for safe returns.

Arbitrage schemes of domestic mutual funds, hit by sizeable outflows in the past 18 months due to falling returns, have devised a way to work around their investment mandate to boost performance. Fund managers are investing more in money-market instruments to lift returns but are ensuring that the scheme is still eligible to be taxed like equity schemes, a key factor that drew investors to this product in the past.

These schemes, which benefit from the price anomalies between futures and underlying shares, are required to invest at least 65% of their corpus in stocks to gain the tax advantage that equity schemes enjoy over fixed-income products. But, with arbitrage opportunities on the wane in a lacklustre market, investing 65% of the corpus has compressed returns. The situation has resulted in fund managers coming out with an idea to lift returns while ensuring tax status of an equity scheme.

Taxation rules state that a scheme will be taxed similar to an equity product if 65% of its corpus is in stocks on the last day of a month and the first day of the ensuing month.

For instance, an arbitrage scheme needs to invest at least 65% of its fund on July 31 and August 1 to gain the tax advantage of equity products. Equity investments beyond a year are exempt from paying capital gains tax. Capital gains tax on redemption before one year is 15%.

For debt mutual funds, the long-term gain is taxed at 10% without indexation and 20% with indexation.

Some fund managers are investing more than 35% of their corpus in money market instruments for most of the other days of a month and trimming it below this level on the two days.

"Since money market instruments are fetching higher returns, a large portion of the fund corpus is being diverted to these securities for most of the month before the month-end. This arrangement is not illegal," said a chief executive officer with a foreign mutual fund, requesting anonymity.

"This arrangement has helped some arbitrage schemes to slightly lift annual one-year rolling returns of late," a top official with another mid-sized mutual fund.

Money market instruments, which are short-term, are returning over 8.5% annually, while the arbitrage fund category has returned almost 6% in 2010 and roughly 4.5% in 2009.

Source: http://articles.economictimes.indiatimes.com/2011-07-26/news/29816623_1_arbitrage-fund-category-arbitrage-schemes-tax-advantage

Immediate Impact of the Policy Has Been an 11 Bps Rise in Yields in the 10 Year G-Sec From 8.29% To 8.40%

Commenting on Reserve Bank of India's First Quarter Review of Monetary Policy, Mr. Ramesh Rachuri, Senior Fund Manager - Fixed Income, Bharti AXA Investment Managers said - The Reserve Bank of India raised the Repo Rate by 50bps to 8.00%, and the Reverse Repo Rate by 50bps to 7.00%. It kept the CRR rate unchanged. It also revised upward the baseline inflation projection for March 2012 to 7.00%. Further, RBI has also stated - “the monetary policy stance will depend on the evolving inflation trajectory, which in turn, will be determined by trends in domestic growth and global commodity prices. A change in stance will be motivated by signs of a sustainable downturn in inflation.”

Stubbornly high and persistent inflation, strong demand pressures, absence of policy initiatives on the supply side and infrastructure, high fiscal deficit due to subsidies and lower tax collections (lowered customs duties on petroleum products due to price rejig) are some of the factors cited for this monetary policy action.

The immediate impact of the policy has been an 11 bps rise in yields in the 10 year G-Sec from 8.29% to 8.40%; rise in 4-5 month CD rates by 20 - 25 bps; and rise in 2 month CD rates by 15-20 bps. In keeping with the anti-inflationary stance, the RBI is expected to keep liquidity in deficit mode below 1% of NDTL (Net Demand and Time Liabilities) of banks, or roughly around Rs.1 Lakh Crores. The current weekly average is a deficit of Rs.63,000 crores.

Monetary authorities also try to target a 'neutral' policy rate at which there is no slack in the economy in terms of potential output. RBI has also implied that after the present hike, the monetary situation is close to normal or neutral and further action would depend on evolving circumstances. Reflecting this, the current implied forward rates of the market shows that the market does not expect another rate hike till the end of the calendar year. So, unless inflation goes out of hand, or there is a 'shock' to the system, RBI would prefer to wait and watch in the mid-quarter review on the 16th of September. What would then be a market mover in the bond and money markets would be liquidity. As we step into the busy season of credit lending with the next policy, corporate borrowing would start and we would see a slight tightening of liquidity, especially at the end of September, coinciding with advance tax payments, in money market securities.

However, what will be in focus would be external developments in Europe and the U.S. How events unfold in the peripheral economies in Europe with a partial debt default and rolling over of borrowing by Greece will be closely watched. The increase in the debt limit in the U.S., which is currently being acrimoniously debated, will also shape liquidity, and interest rates, as also lowering of aggregate demand and impact on employment. The moot point is that all the external indicators suggest possible lowering of aggregate demand, and hence impact on commodity prices like crude oil, food (soft) commodities, etc., which the RBI is watching like a hawk.

In light of the above, and given the possibility of a pause in rate hikes till atleast September (and possibly till the end of the current calendar year), being coupled with a falling off of CD issuances from banks due to contraction between credit and deposits, we would judiciously extend duration, wherever feasible, especially in our Bharti AXA Short Term Income Fund, and Bharti AXA Regular Return Fund.

Source: http://www.adityabirlamoney.com/news/493398/10/22,24/Mutual-Funds-Reports/Immediate-Impact-of-the-Policy-Has-Been-an-11-Bps-Rise-in-Yields-in-the-10-Year-G-Sec-From-8-29-To-8-40-

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