Don't switch out of debt funds

We have been recommending the long-dated debt fund strategy for some time now. While it has generated handsome returns in the past, conditions are not rosy for investors who got in only in the last three months. Income funds have generated absolute returns of only 0.97% in the last three months while the average longand medium-term gilt fund has lost money .

So what went wrong? After falling for more than 18 months, the 10-year yield remained almost flat the last three months before starting to inch up in the last few days. The 10-year yield is now placed at 7.87%, 22 bps higher than the recent low of 7.65% on 2 February . To find out where the yield is headed, we need to take a look at the factors that contributed to its recent spurt.

First, the spurt in crude prices from its recent lows has raised doubts about the low inflationary situation in India.Brent crude is at $69 per barrel, a more than 40% jump from its January low.However, experts think this spurt is temporary. "What is happening on crude is a technical bounce," says Rajeev Radhakrishnan, Head, Fixed Income, SBI Mutual Fund. This is because there is no reduction in supply by OPEC. "Crude should stabilise between $60 and $70. If prices go above $70, shale producers who shut down production may come back," says Radhakrishnan.

Food inflation is another worrying factor. A below average monsoon is predicted too. However, experts remain unfazed. "The corelation between monsoon and inflation is low," says R. Sivakumar, Head of Fixed Income, Axis Mutual Fund. "Food inflation is due to the increase in minimum support price and the government has made only a very small increase this time," he adds.

The CPI-based inflation, which the RBI uses, is still above 5%. However, the WPI-based inflation is in the negative zone for the last five months and should help bring down the CPI-based inflation.Growth not picking up as expected is another reason for a benign CPI-based inflation. "We are growing well below our potential rates. With enough spare capacity , manufacturer's pricing power is low and this should help inflation to shift lower," says Radhakrishnan. That would mean the RBI's CPI-based inflation target of 6% by January 2016 will be achieved. "Inflation should be close to 5% in the next year," says Sivakumar.

The weakness in the rupee is another factor holding the RBI's hand. The dollar has been appreciating over the last few months due to US rate hike fears and has already reached `64.05. Though RBI wanted a small depreciation in the rupee due to inflation differential, it would not like a sudden crash. Another factor irking RBI is the behaviour of banks, which have not passed on the benefits of the last 50 bps cuts to custom ers. However, the banks have started passing on some benefits. With more banks participating, RBI may restart rate cutting soon. "The next rate cut from RBI may happen before June 30," says Kumar.

The spike in 10-year yield can also be linked to technical factors in the market. RBI is about to issue new 10-year papers, so existing investors are getting out of current ones. "The yield on the existing 10-year paper is high because of the illiquidity premium and the yields on new papers are usually 15 bps lower than the old papers," says Indranil Pan, Economist, Kotak Economic Research. With the FII limit on government securities reached, there is no additional FII inflow here. Any increase in limit will result in fresh bout of buying and bring the yield down again.

Experts are of the view that the 10year yield will come down in a year."The current yield of 7.95% is an aberration and should come down to 7.25% in 5-6 months," says Kumar. Sivakumar and Radhakrishnan agree.

Stick with long duration: Investing in long duration funds is the best strategy to make money from a fall in interest rate. The price of bonds and yield are inversely co-related and bond prices move up when yields go down.Existing investors should stick with long duration funds instead of shifting.They can also consider putting in fresh money into this segment. However, note that the current yield is below 8%."Only investors with long-term holding period and strong views can make money this year," says Pan. "There will be short-term volatilities in long duration funds and instead of selling, they should hold on," says Vidya Bala, Head, Mutual Fund Research, FundsIndia.

Gilt or income: "Income funds are better for retail investors, as gilt funds are for those who have specific views on gilt yields," says Sivakumar. The advantage of income funds is that they can get the benefit of the higher yield in corporate debt papers also. Income fund managers usually invest in corporate debt when the difference between the gilt yields and AAA rated corporate bonds are high and get back to gilt then the yield difference is low. Pure gilt fund investors, who time the gilt yield cycle correctly, may also have to deal with higher taxation. The Indian gilt yield cycles takes 18-24 months. Since the minimum holding period for long-term capital gain for debt funds has been increased to 36 months, active investors who exit before three years will have to pay short-term capital gains tax.

Short-term for stability: Investors who seek stability can go for short-term income funds. Here the returns come through the accrual method. These funds have generated decent returns in the past year. However, short-term rates are expected to fall. A better option are dynamic funds, where the fund manager takes the call on maturity based on his reading of interest rate movements.

Source: http://timesofindia.indiatimes.com/business/india-business/Dont-switch-out-of-debt-funds/articleshow/47410775.cms

Debt funds may be better than tax-free bonds

Public sector undertakings such as Indian Railway Finance Corporation and National Highways Authority of India will soon come out with their tax-free bonds. The biggest advantage for investors is that the interest earned from these bonds is entirely tax-free. But the disadvantage is that these bonds lack liquidity. While investors can sell them through exchanges since they are listed bonds, it becomes difficult to do so as they are not traded frequently.

One way to get around this is to invest in an active bond, say an income fund, that invests in the taxable bonds of the same PSUs. This way you are assured of the same credit quality and higher yields. Yields on taxable bonds can be about 100 basis points higher than tax-free bonds.

"For us it does not make sense to buy tax-free bonds because then where can we sell the bonds? On the other hand investing in the taxable bonds of the same PSUs makes sense as yields are higher. This is a strategy we have been following for our debt funds for some time now. And if you remain invested for three years, you will get benefit of indexation,'' says Namdev Chougule, Executive Director, Head-Fixed Income, J P Morgan Asset Management.

For instance, J P Morgan has non-convertible debentures of PSUs like Power Finance Corporation, Rural Electrification Corporation, Airports Authority of India, IRFC, Power Grid Corporation of India, etc. All of these are companies also issue tax-free bonds.

The trade-off is between the higher returns generated by the mutual fund and the post-tax benefits of tax -free bonds, says Sudip Bandyopadhyay, MD and CEO, of Destimoney Securities. "Even in a debt fund it is possible to reduce the tax by opting for the growth option and holding your investment for three years. But it will attract long-term capital gains after three years. However, the clincher for mutual funds is the liquidity. Investors can sell at any point of time. In case of tax-free bonds they are stuck with the bonds if they can't find buyers,'' he says.

Besides with interest rates going down and bond prices going up, both mutual funds and tax-free bonds will give the benefit of capital appreciation. So savvy investors can consider the mutual fund route, he adds.

Those investing in mutual fund will have to keep in mind intermediation costs and other expenses, which can eat into the gains, points out Jyoteesh  ‎EVP & Head Marketing, Distribution & Product at HDFC Securities. "If you invest directly in tax-free bonds it is transparent and you know what you are investing in. But in case of mutual funds often investors don't know what kind of papers the fund is investing in,'' he says.

Currently, there is a lot of demand for tax-free bonds in the secondary market, he adds.

Tax-free bonds are usually issued for long term periods of 10-20 years and are preferred by High Networth Investors, who do not want to pay tax. This time around experts feel that a lot of money from equity gains could flow into tax-free bonds as and when they hit the markets.

If you sell tax-free bonds before maturity, the capital gains will be taxed. So, investors will have to hold them till maturity to get the tax benefit.

Source: http://www.business-standard.com/article/pf/debt-funds-may-be-better-than-tax-free-bonds-115051400720_1.html

RBI keeps repo rate unchanged, cuts CRR by 25 bps

The Reserve Bank of India on Tuesday left its key policy rate unchanged in its second quarter (July-September) monetary policy. However, it cut cash reserve ratio by 25 basis points to 4.25%. CRR is the portion of deposits banks are mandated to keep with the RBI.

With the CRR cut, the central bank will infuse Rs 17,500 crore liquidity into the system. Repo, the policy rate at which banks borrow money from the regulator remains at 8% while reverse repo, used to lend money to RBI is at 7%.

"The reduction in the CRR is intended to pre-empt a prospective tightening of liquidity conditions, thereby keeping liquidity comfortable to support growth," D. Subbarao, the governor of RBI said in a statement.

"It anticipates the projected inflation trajectory which indicates a rise in inflation before easing in the last quarter. While risks to this trajectory remain, the baseline scenario suggests a reasonable likelihood of further policy easing in the fourth quarter of 2012-13. The above policy guidance will, however, be conditioned by the evolving growth-inflation dynamic."

Source: http://www.moneycontrol.com/news/economy/rbi-keeps-repo-rate-unchanged-cuts-crr-by-25-bps_774839.html

Indian bonds yields little changed

Indian federal bond yields ended little changed on Tuesday as dealers preferred to stay light ahead of a central bank rate meeting and the fiscal second-half borrowing numbers later in September.

Dealers are also waiting to see whether the government will increase diesel prices, a contentious political issue, as any rise will push up freight and input costs.

The Economic Times reported on Tuesday that the government may raise diesel prices by 4-5 rupees a litre after the current session of parliament ends on Sept. 7.

While such a move will be inflationary in the near term, the central bank itself has been arguing that the government raise subsidised fuel prices to cut its bloated deficit bill.

"The key trigger will be the second-half borrowing. Overshooting is a done deal with the market expecting 500-600 billion rupees of extra borrowing," said Mahendra Jajoo, head of fixed income at Pramerica Mutual Fund.

India is scheduled to borrow 5.7 trillion rupees in the current fiscal year that ends in March, 65 per cent of which will be completed during April-September.

But the government is unlikely to stick to its 5.1 per cent fiscal deficit target, and will have to borrow more to fund any further gap.

The central bank is unlikely to provide any relief by lowering rates as it views the current inflation levels as too high.

RBI is expected to keep its key interest rate steady this month, a Reuters poll showed.

Jajoo said the bond market will also await signals on liquidity from the RBI, specifically as to when it resumes its open-market bond purchase, which it stopped in end-June.

Liquidity remains comfortable with the overnight benchmark rate or Mumbai Interbank Offer Rate slipping below 8 per cent for the first time in 11 months.

However, the cash shortage is expected to accentuate in mid-September when corporates pay advance tax, which will result in outflows to the tune of 500-600 billion rupees from the banking system.

The benchmark 10-year bond yield ended 1 b asis point lower at 8.21 per cent.

Total volume on the central bank's electronic trading platform was less than usual at 160.25 billion rupees.

The benchmark five-year swap rate was unchanged at 7.16 per cent, while the one-year rate was down 1 bp to 7.79 per cent.

Source: http://economictimes.indiatimes.com/markets/bonds/indian-bonds-yields-little-changed/articleshow/16252338.cms?curpg=2

India Inflation Unexpectedly Quickens, Curbing Rate-Cut Room

Indian inflation unexpectedly accelerated in April, crimping the central bank’s scope to bolster economic growth by extending interest-rate cuts. Stocks fell, erasing earlier gains.

The benchmark wholesale-price index rose 7.23 percent from a year earlier, after climbing 6.89 percent in March, the Ministry of Commerce and Industry said in a statement in New Delhi today. The median of 32 estimates in a Bloomberg News survey was for a 6.67 percent gain.

Reserve Bank of India Governor Duvvuri Subbarao signaled last month that inflation might limit the room for further cuts after he slashed the benchmark rate by half a percentage point, flagging price risks from the fiscal deficit, energy costs and a weaker rupee. Greece’s political turmoil and a deepening debt crisis in Europe are increasing pressure on Asian nations to support growth as exports falter from Taiwan to Malaysia. China cut banks’ reserve requirements on May 12 to revive demand.

“The Reserve Bank of India faces somewhat of a dilemma,” Robert Prior-Wandesforde, Singapore-based director of Asian economics at Credit Suisse Group AG, said in a note after the report. “Our guess is that the chance of a June rate move has diminished.”

Sensex Falls

The BSE India Sensitive Index (SENSEX) fell 0.7 percent as of 2:22 p.m. in Mumbai, heading for the longest losing streak this year as State Bank of India and ICICI Bank Ltd. (ICICIBC), the nation’s two biggest lenders, erased advances of more than 2 percent each.

The yield on the 8.79 percent note due November 2021 rose two basis points immediately after the inflation data, before sliding five basis points, or 0.05 percentage point, to 8.52 percent.

The central bank lowered the repurchase rate on April 17 for the first time since 2009, by 50 basis points to 8 percent. A report last week showed Indian industrial production unexpectedly contracted in March as weaker domestic demand and tumbling exports hurt the economy.

“The inflation numbers are a very uncomfortable statistic,” Chakravarthy Rangarajan, chairman of the Prime Minister’s Economic Advisory Council, said in New Delhi today. “Many people have been calling for an easing in monetary policy but it makes it difficult for RBI to moderate policy. It is not a good sign.”

Worst Performer

Concern India’s outlook has worsened because of trade and fiscal deficits, political gridlock, elevated inflation and faltering global growth has pushed the nation’s currency toward a record low. That prompted the central bank to say last week exporters must convert half their foreign-currency earnings into rupees as it stepped up efforts to check the decline.

The currency weakened 0.5 percent to 53.885 per dollar in Mumbai. It is down almost 17 percent in the past year, the worst performer in a basket of 11 most-traded Asian currencies tracked by Bloomberg.

Governor Subbarao’s 13 interest-rate increases in the last two years helped tame price pressures in a nation where 75 percent of the people live on less than $2 a day. The wholesale- price inflation gauge has fallen below 9 percent in 2012, after breaching that level most of last year.

Aside from cutting the benchmark rate, the central bank has also reduced the amount of deposits lenders must set aside as reserves twice this year by a combined 125 basis points, to 4.75 percent, to ease cash shortages in the banking system.

Fastest Inflation

Credit Suisse predicts India will cut its repurchase rate by another 125 basis points by March 2013, Prior-Wandesforde said today.

Still, the central bank’s scope to cut interest rates further to boost growth is constrained by the threat of price increases, Ashima Goyal, a member of the bank’s technical advisory committee, said in an interview in Mumbai last week.

While the wholesale price gauge has cooled after the Reserve Bank raised rates by a record 3.75 percentage points from mid-March 2010 to October last year, India still has the highest inflation in the so-called BRIC group of biggest emerging markets that also includes Brazil, Russia and China.

“The inflation number underscores that the room to ease monetary policy is quite limited because there are still upside risks to inflation,” said Leif Eskesen, Singapore-based chief economist for India and Southeast Asia at HSBC Holdings Plc. “There isn’t a lot of spare capacity in the economy because growth has slowed on the back of policy paralysis, lack of structural reforms and therefore it makes inflation a structural problem rather than a cyclical one.”

Maruti Profits

Maruti Suzuki India Ltd., the nation’s biggest carmaker, posted a 3 percent decline in fourth-quarter profit because of high raw material costs and discounts on some models.

The country imports 80 percent of its annual crude requirements and the government compensates state oil firms for selling products below market prices.

Asia’s third-largest economy probably expanded 6.9 percent in the 12 months through March 2012, the least in three years, government estimates show. Standard & Poor’s cut India’s credit outlook to negative from stable last month, putting at risk its investment grade status.

Source: http://www.bloomberg.com/news/2012-05-14/india-inflation-unexpectedly-accelerates-curbing-rate-cut-scope.html