Liquid funds to give returns in line with money markets

Sebi appears to be taking a leaf out of international experiences in valuation of liquid funds.

The Securities and Exchange Board of India (Sebi) has decided to change the valuation norms for debt and money-market instruments held by mutual funds. Instead of the earlier norm requiring these instruments to be marked to market, where the residual maturity exceeded 91 days, the new norms would see instruments with maturities of at least 60 days being marked to market (when these securities are not traded).

Over a period of time, Sebi has reduced the mark-to-market tenor from 1 year to 91 days to 60 days. In making the change, Sebi has expressed its desire that all types of investors—existing as well as those seeking to purchase or redeem—are treated fairly. Marking to market ensures that the portfolio value closely reflects the realizable value of the assets. In the case of equity funds, the well-traded and liquid nature of the equity market ensures that mutual fund net asset values (NAVs) capture the current value of the portfolio. The debt market remains illiquid and non-traded securities are valued using a valuation model.

For securities with up to 60 days of maturity, the valuation method would remain the same (amortization at cost). In amortization, there is the possibility that the price of the security could be substantially different from the market price. This could lead to over/under-valuation of the portfolio. The lowering of the mark-to-market threshold would ensure that the extent of valuation difference is minimized both in duration and amount. The benefit of the new norms would be in the reduction of over-valuation, which could affect the fund if it were to be subjected to large redemptions.

Sebi appears to be taking a leaf out of international experiences in valuation of liquid funds. In the US, for example, money-market funds are required to calculate a “shadow” price, which is disclosed with a two-month lag. In Europe, money-market funds are allowed to amortize as long as the weighted average maturity is less than 60 days (source Bank for International Settlements). The rationale for amortization in valuation is that for short maturity debt, daily volatility is quite small and the difference to market price would be negligible. For example, a three-month certificate of deposit (CD) would see its price change by only six basis points (bps) (0.06%) for a 25 bps change in the yield. A 60-day CD would see the price change by 4 bps for a similar magnitude change in yield.

Indeed the actual experience in the US suggests that deviations in the shadow price remain small—that the amortized value is close enough to the real value of the fund (source Investment Company Institute). Thus, the shadow price has not had a negative impact on the growth of the money-market industry. In this context, Sebi’s step may be seen as more restrictive than the international norm as it requires the marked-to-market prices to be used in the fund’s NAV rather than as a shadow NAV. This may result in an increase in investor perception of volatility even where it may not be justified.

The impact of the changed valuation norms would be felt most in the category of liquid funds, which invest exclusively in instruments that mature within 91 days. This category was defined by Sebi to provide a low volatility option for investors seeking to invest for the short term. The low-risk nature of this category has made it the option of choice for companies and retail investors in mutual funds who desire to park their short-term surplus. In view of the changed valuation norms, liquid funds are likely to change their portfolios to invest in instruments with shorter tenor. This would be consistent with the investor preference of low volatility.

For the money markets, liquid funds remain key providers of liquidity. For example, liquid funds are among the largest investors in CDs and commercial papers (CP), apart from being key participants in repo and collateralized borrowing and lending obligation. Restricting deployment avenues for liquid funds may result in lower liquidity in these key markets as funds move into safer assets.

In summary, the primary rationale for investing in liquid funds—earning short-term interest rates with low volatility—is not changed by the change in valuation norms. Mutual funds will adapt to the new guidelines and liquid funds would continue to provide returns in line with those prevailing in the money markets.

Source: http://www.livemint.com/2012/02/13211552/Liquid-funds-to-give-returns-i.html

Taking advantage of rate uncertainty

A number of fund houses prepare to launch these open-ended schemes

Investors in debt funds are in a bind. While there are indications that Reserve Bank of India is likely to cut indicative rates, there is uncertainty on when it will happen and by how much.

The existing rates of interest — eight per cent plus — is good. But if rates fall, it could be better for investors due to rise in prices. To take advantage of this uncertainty, a number of fund houses are lining up to launch open-ended dynamic bond funds.

Three fund houses — IDBI Mutual Fund, Pramerica MF and Union KBC — have already done so. Two more, Daiwa MF and Principal MF, have filed offer documents with the regulator, the Securities and Exchange Board of India (Sebi).

Dynamic bond funds, as the name suggests, are able to take advantage of rate cuts or rises by altering their portfolio. But here lies the danger as well.

Sometimes, fund managers can get their churning right or it can go haywire as well. So, returns can widely fluctuate.

In the one-year category, return on dynamic funds is 9.78 per cent. However, the best performing fund — SBI Dynamic Bond — has given a the return of 12.99 per cent, while the worst-performing — Tata Dynamic Bond A & B — have given a return of 7.51 and 7.52 per cent, respectively.

“The debt fund track record of the fund manager and the fund house plays a very important role in deciding which dynamic bond fund one should choose. The investment process and philosophy should be looked at,” explains Mahendra Jajoo, director and CIO (fixed income) at Pramerica MF. Investors need to check the track record before taking a call.

The trick in these funds lies in being made to predict the rate fluctuations correctly and change the portfolio. “When the interest rate is rising, bond prices fall and the fund manager should be able to decrease the duration of the bond; short-term bonds face a lower impact. And, when the interest rate is falling, they should be able to increase the duration of the bond,” says Gautam Kaul, fund manager, IDBI MF.

The taxation on these funds is computed like any other debt scheme. Long-term capital gains tax is calculated at 10 per cent with indexation and 20 per cent without it. In the short term, capital gains will be added to your income and taxed, according to slab.

But since the risk involved with investing in these funds is not very high, Suresh Sadagopan, a certified financial planner,says one can allocate 20-40 per cent of the debt portfolio in these funds. “From a 6-18 month perspective, these funds are far more tax-efficient and will give you better returns than a bank fixed deposit, a national savings certificate or PPF. They are less risky than corporate bonds as well.”

In terms of cost, they are comparable. For dynamic bond funds, the expense ratio can be anywhere between 0.7 per cent and one per cent, higher than most short-term debt funds. However, the expense ratio is comparable to income funds (higher tenure debt funds).

The exit loads vary between fund houses. It is around 0.5 per cent and for six months to one year. Some fund houses do not charge exit loads.

Source: http://business-standard.com/india/news/taking-advantagerate-uncertainty/464600/

Four fund managers' view on how equity markets are likely to take in coming months

They are like players of the Indian cricket team. A good show earns kudos while a poor one brings brickbats. That they manage public money makes them even more accountable. Meet some of the country's leading fund managers who have been managing your money convincingly, both during rallies and in downturns of the equity markets. In candid conversations with ET , top executives of the mutual fund industry share not only their investment strategies and biggest challenges, but also some of their best and not-so-good investment decisions, besides giving their view on the direction equity markets are likely to take in the coming months.

Sandeep Kothari, Fund Manager, Fidelity

Worldwide Investment

1) What makes you stay back in your current organisation?

Fidelity is a good company with a good investment culture. Also, as an asset manager I believe that one needs to build a track record in managing people's money and to build trust. You can not hop around jobs to do that.

2) What is your philosophy for equity investing?

There is no growth or value sort of philosophy per se. I believe one needs to look at businesses, scalability of business and pay the right value for it. The idea is to identify good businesses and grow with those businesses. 

3) What triggers your investment decision?

I think paying the right price is very important. However, defining the right price is very subjective and influenced by a lot of macroeconomic factors.

4) Your biggest challenge as an equity fund manager.

Not losing out on focus if schemes underperform and not getting carried away if they do well.

5) Your best investment decision.

Did not get carried way by the infrastructure boom in 2007 though the decision had begun to hurt the performance of the schemes. Sticking to the conviction of not investing in these companies was very challenging and difficult, but eventually it paid off well.

6) Investment decision you regret.

We exited a couple of stocks at the lowest prices ever hit by that counter and lost money since we had bought them pretty expensive. While we did not have significant exposure, we do regret not having done enough research before taking the exit call.

7) Investment ideas for the coming months.

We expect the banking and financial cycle to turn around this year and if that happens then the capital investment cycle would also increase.

8) Do you invest in your own schemes?

I have invested in all three of my schemes, Equity, India Growth and Tax Advantage though SIPs. In fact, a large part of my equity investments is in my own funds.

9) Your take on Indian equity markets.

Markets are volatile and we expect volatility to continue. But we do believe in cyclical recovery if government starts moving on the policy. But if reforms do not happen, sentiments may turn back equally quickly.

Apoorva Shah, Executive VP & Fund Manager, DSP Blackrock Asset Management

1) What makes you stay back in your current organisation?

I respect the core values of DSP that are honesty, integrity and an open culture. This organisation has allowed me to work in different capacities and graduate from sales to fund management.

2) What is your philosophy for equity investing?

I don't have a theory on how the market should behave but I am flexible in my approach. I accept the way in which it behaves and adapt myself to it.

3) What triggers your investment decision?

Stock picking, especially in the mid caps, is on the basis of size of opportunity, scalability, pricing power and management quality in terms of their ability to execute and track record.

4) Your biggest challenge as an equity fund manager.

To read the changing markets from time to time, and to meet investor expectations.

5) Your best investment decision.

Going extremely defensive in 2008 with overweight positions in consumer staples, pharma and IT despite they being expensive. We avoided financials and cyclical stocks then.

6) Investment decision you regret.

Couldn't aggressively change the defensive character of the portfolios in 2009. Should have embraced the financial sector in March 2009. Got apprehensive about the potential bankruptcy in the system and avoided financials.

7) Investment ideas for the coming months.

We have remained defensive for a major part in 2011, but are looking forward to cut down on defensive bets. Looking to invest in certain beaten down and cyclical counters like financials, capital goods, and infrastructure.

8) Do you invest in your own schemes?

I have currently invested in DSP Balanced fund and the MIP. I have a lump sum investment in both these schemes.

9) Your take on Indian equity markets.

We have had high quality stocks outperform till last year and there was a high-risk aversion. Now there is a love for risk that has come again. Valuation gap between quality stocks and beaten down ones has expanded substantially. Quality stocks are very expensive. Need to shift the portfolios based on a value approach, on the margin.

Anand Radhakrishnan, Sr VP & Portfolio Manager - Equity, Franklin Templeton Asset Management

1) What makes you stay back in your current organisation?

The only business that we do in Franklin Templeton is asset management and as an investment management professional I like to work for an organisation where the heart and the soul belongs to investment management. It is one of the very few organisations to have emerged as the benchmark for some of the best industry practices globally.

2) What is your philosophy for equity investing?

Investing in businesses that can withstand cycles and deliver good returns in both good and bad times.

3) What triggers your investment decision?

It is essentially bottom-up based GARP approach, but we also take value based contrarian calls.

4) Your biggest challenge as an equity fund manager.

To identify long-term winning ideas in the market.

5) Your best investment decision.

Investing in some of the large-cap stocks where we had high conviction like HDFC Bank, Bharti Airtel, Lupin, Kotak Bank and Idea. Investing in Cummins in the industrial segment turned out to be a winning idea for us.

6) Investment decision you regret.

Not exiting some of the extremely high-valued infrastructure stocks in 2007. One costly decision in 2011 was to sell consumer staples too early on valuation concerns.

7) Investment ideas for the coming months.

With interest rates very low globally, it is not remunerative investing in bonds, while dividends in several equities are higher.There was a case of undervaluation of equities. Markets is on a corrective course where the undervaluation of equities will reduce.

8) Do you invest in your own schemes?

Most of my equity investments are in our schemes. So if my schemes do well even we do well.

9) Your take on Indian equity markets.

Hopefully, a number of local issues will get solved once the elections are over. Hence 2012 will be a better year compared to 2011. We are cautiously reacting to these changes, while waiting for confirmations. We are not betting on a big recovery in 2012. We believe that some more of what we have seen is required to enable bigger bets on pro-cyclical stocks.

Kenneth Andrade

Head - Investments, IDFC Asset Management

1) What makes you stay back in your current organisation?

IDFC has given me independence and freedom of thought to implement what I wanted to. I have been associated with the organisation when it just started off in equities and now I have taken it up as a challenge to scale it up.

2) What is your philosophy for equity investing?

I look for great start-ups and for great people who can start organisations. Then once the business hits a certain inflexion point, you need to see if it has enough bandwidth to scale up.

3) What triggers your investment decision?

I like companies that go for market share, especially in down cycles.

4) Your biggest challenge as an equity fund manager.

Finding the right scale of investment without diluting the return profile of the portfolio.

5) Your best investment decision.

Not having infrastructure stocks in the portfolio in 2008 and banking and financials in 2011. Also, an early participation in the consumption cycle in early 2009 helped.

6) Investment decision you regret.

We got some of our exit strategies wrong, like textile, sugar and solvent extraction in the mid of 2010. Our exit strategies in many businesses have not been the best.

7) Investment ideas for the coming months.

We are kicked about the NBFC space. While the entire banking system in the last decade extended their balance sheets to infrastructure, their lending to the retail segment has not been impressive. NBFCs have shown a significant growth in retail lending which we like.

8) Do you invest in your own schemes?

There is too much off a compliance issue. So I refrain from investing in my own schemes. Currently, my largest investment is IDFC itself. I do not invest in mutual funds because of regulatory problems.

9) Your take on Indian equity markets.

In the current decade, corporate & bank balance sheets and the fiscal position are in mess. The de-leveraged part of the economy is the customer. So my sense is if the interest rates were to soften, the first thing to take off will not be capital goods or infrastructure but the car sales and mortgages.

Source: http://articles.economictimes.indiatimes.com/2012-02-13/news/31055165_1_fund-managers-equity-markets-investment-strategies/2