Go for corporate bonds, not gilts, in 2012

Government securities may yet see prices dip, as their supply over the next few months is expected to be high. Corporate bonds, especially those from top-rated companies, may deliver better gains.

For most of 2011, interest rates were on the rise, whetting the appetite of investors for debt investments. With rate cuts expected after March, what's the outlook for the bond market?

Interest rate outlook

The RBI has clearly indicated that it will stop raising interest rates. So markets are now betting on policy rates coming down. The recent moderation in inflation and slowing economic growth have supported this view.

The markets are expecting the RBI to cut repo rates by 50 to 75 basis points over the next 12 months. The cuts are expected to begin after July but we think the cuts may not be as steep as in 2008-09 when rates fell by 4.25 percentage points over six months.

This is because India's troubles with inflation, the key metric that the apex bank is watching, may not yet be over.

First, although food and primary inflation have abated recently, manufacturing inflation has not. Pending increases in coal prices and electricity tariffs may also feed into manufacturing inflation.

Second, though global commodity prices have cooled off recently, rupee weakness has offset much of this correction for Indian importers.

Third, crude oil prices, a key inflation driver, have not corrected by much. Any oil price hikes post-election may further fuel inflation.

Time not right for gilts

Based on the expectation of rate cuts, benchmark 10-year gilt yields that hit a high of 9 per cent in November have cooled to 8.26 per cent now. But this may not be an opportune time to enter gilts for two reasons.

One, the supply of gilts is likely to rise over the next three months owing to a slippage in the fiscal deficit targets. This may pressure gilt prices and push up yields.

Debt markets early in 2011 cheered the lower borrowings announced by the government. But a fall in small saving inflows and lower disinvestment income has already led to government hiking its borrowing target by close to Rs 92,872 crore for this fiscal (a good 22 per cent more than the budgeted market borrowings).

Two, banks are today heavily invested in government bonds as the credit off-take continues to be subdued. If demand for credit increases in coming months, banks may reduce gilt investments, also pressuring prices.

These factors suggest that this may not be a good entry point into long-term gilts.

The only liquid avenue available for retail investors interested in government securities is through gilt mutual funds.

Returns on these have been quite volatile. Ten-year gilt yields have swung from 5.2 to 9.4 per cent in the last five years. In addition, because of their longer-term investments, these funds register higher capital gains or losses on their NAV based on whether interest rates fall or rise. The average returns on gilt funds over the last five years have been 6.6 per cent. Timing your entry well is quite important while investing in gilt funds.

Investors seeking safety, however, can instead get exposure to top-rated quasi government entities through some ongoing bond issues. For instance, upcoming tax free bonds of Indian Railway Finance Corporation, HUDCO and infrastructure bonds of REC, PFC and IDFC can be considered.

Interest rates on such bonds are linked to government security yields. Interest rates of close to 8 per cent for tax-free bonds are attractive for investors in the high-tax bracket.

Corporate debt better

While long-term gilts don't appear attractive now, bonds from top-rated corporates do. From here, top-rated corporate bonds may outperform gilts for two reasons.

One, as Ritesh Jain, Head of Fixed-Income at Canara Robeco says, the balance sheets of top-rated corporates are in much better shape than the government. While the government is on a borrowing spree, top Indian companies have been cutting back on their investment plans, reducing debt on their balance sheets and hoarding cash.

Any issuances by them are, therefore, likely to be quickly picked up by institutional buyers.

Two, thanks to the same cautious mood, the supply of paper from them is also not likely to be high. In fact, this appears to be the reason why since March 2011, yields on AAA rated corporate bonds have not risen as much as government security yields.

Focus on the short-term, play it safe

Agreed, corporate bonds now appear a better bet than gilts. But should investors buy short-term (1-3 years), medium-term (3-5 years) or long-term options (5 years-plus)?

Those considering these options would essentially have to take the mutual fund route, which offers all three kinds of products. The short and medium-term funds appear better bets today.

Flat yield curve

While interest rates are expected to moderate from current levels (See accompanying story on Interest rate outlook), the fall in policy rates this time around may not be as steep as in 2008-09.

Gilt and long-term income funds, which bet on 5-year-plus instruments, usually make the most capital gains from a fall in interest rates. Shorter-term funds benefit more from interest rate accruals.

This suggests that moderate falls in interest rates would make for limited gains on bond and gilt mutual funds. Investors, therefore, can continue to look at short-term bond funds.

The other big reason why short and medium-term funds appear good options is the flat yield curve. Essentially, short-term bonds (1-2 years) today offer much the same yields as long-term bonds.

Under normal circumstances the yields on short-term bonds should be lower than long-term investments, as one takes the additional risk of interest rate volatility in the long term.

This suggests potential for yields at the shorter end to come down (and bond prices go up) once the rate cuts are effected.

Dhawal Dalal, Head, Fixed-Income, DSP Blackrock Mutual Fund, suggests investing in either short-term debt funds or the dynamic bond funds to play this trend in 2012. Dynamic bond funds have flexibility to increase or decrease duration based on the prevailing interest rates.

Look beyond returns

Fund managers, however, also warn it is best to play it safe when it comes to corporate bonds.

AAA bond investments are the preferred choice. While AAA- rated bond yields may decline to close the gap with gilts, bonds that enjoy lower ratings may not see an equivalent dip in yields.

In fact, bond issues from NBFCs with credit ratings ranging from AA+ to AA-, which offered high yields last year, are now trading lower than their par value.

Highlighting the riskiness of these bonds, Canara Robeco's Ritesh Jain says, “Slowing investment activity, deteriorating currency, lack of clarity in Euro Zone and high cost of debt will continue to put pressure on sub-prime corporate balance sheets. Hence the chances of credit downgrades increase.”

This suggests that while choosing a debt fund too, investors shouldn't merely look at the returns. Portfolio risk is a key factor. Under normal circumstances, the risky portfolio may give good returns as interest receipts flow in, masking the risk.

But during periods of crisis, where corporates are facing the risk of falling interest coverage and debt refinancing woes, these funds may take a hit.

Dalal points out that given the open ended-nature of DSP's debt funds, investors can exit anytime. This means the investments have to be liquid to meet the demands of investors. Therefore, they predominantly invest in banks' certificate of deposits and AAA bonds.

Source: http://www.thehindubusinessline.com/features/investment-world/article2801356.ece?ref=wl_companies

SEBI wants AMCs to launch pension products.

Market regulator Securities and Exchange Board of India today said fund houses should launch pension products, so that retirement money can be brought into the capital market.

Noting that retirement and pension money is not coming to the market, Sebi Chairman U K Sinha wondered why asset management companies (AMCs) are not launching funds aimed at attracting pension money.

"Retirement and pension money is not coming into the market. It is legally possible that retirement money can be invested in the markets ... why are AMCs not able to launch pension funds?" Sinha said at India Investment Conference here.

"We are passing through very difficult times. Margins and volumes and flow of fresh money are coming down. What you do in such a situation? We need to start taking measures," Sinha said, adding that level of participation in the markets by households is very low.

In future, Sinha said, Sebi will be regulating alternative investments. "Currently we are looking at regulations on distributors and investor advisers."

About 50 per cent of mutual fund business is done through distributors who are not regulated at all, he said.

On the proposed new IPO norms, Sinha said, "We are looking at a review of the entire IPO process, as to who would participate, and in what manner and how to reduce the timelines."

Replying to query on insider trading norms, Sinha said, "We will take strict action against market manipulators."

Source: http://articles.economictimes.indiatimes.com/2012-01-13/news/30623887_1_pension-funds-pension-money-pension-products

CFO Rahman named UTI AMC acting CEO

The Board of UTI Asset Management Company (UTI AMC) has appointed its Chief Finance Officer Imtaiyazur Rahman as the acting CEO with immediate effect till the appointment of a new chairman and managing director. The company has been headless for nearly a year since its former CMD UK Sinha quit in February 2011.

"Rahman will look after the day-to-day operations, working closely with the rest of the senior leadership team," the company said in a statement. The Board has also appointed PN Venkatachalam, retired managing director of SBI, as an independent director. Rahman is a member of the four-member management committee of the mutual fund. The shareholders of UTI AMC were on a collision course over the selection of a new CMD, with LIC, State Bank of India, Bank of Baroda and Punjab National Bank on the one side, and the US-based global investment management company T Rowe Price on the other.

The bone of contention between the state-owned financial institutions and T Rowe Price was the inclusion of Jitesh Khosla, a 1979-batch IAS officer, in the panel of prospective candidates to be interviewed by the shareholders. It is learnt that Khosla, who is the brother of Omita Paul, adviser to Finance Minister Pranab Mukherjee, was not in the shortlist prepared by the Board’s human resources committee. Khosla, who was until recently with Indian Institute of Corporate Affairs, an institution under the Ministry of Corporate Affairs, is currently additional chief secretary of Assam.

T Rowe Price which holds 26 per cent stake in UTI AMC was in favour of bringing a professional from the mutual fund industry to head the company.

As market regulator Sebi also directed the UTI AMC not to launch any scheme till it gets a chief, the company was unable to come out with any product since last February. Sebi allowed the company to launch a new scheme only recently. Two independent directors — Anita Ramchandran (who was the acting chairperson of UTIAMC) and Prithvi Haldea — have also recently stepped down from the board citing personal reasons.

Source: http://www.indianexpress.com/news/cfo-rahman-named-uti-amc-acting-ceo/899174/0

Bonds Beating Gold for Funds on Slowest Inflation Since ’09: India Credit

Investors in India are shunning gold while adding to holdings of government bonds, betting that policy makers will cut borrowing costs as inflation slows to the least in two years. 

Assets managed by funds that buy bullion shrank 4.3 percent to 91.5 billion rupees ($1.8 billion) in December, while those that trade in rupee-denominated sovereign debt increased 17 percent to 31.2 billion rupees, according to the Mumbai-based Association of Mutual Funds in India. Gold imports by the world’s biggest buyer may slump 48 percent in the three months ending March from a year earlier, the Bombay Bullion Association said this month.

Government notes are rallying before data next week that economists predict will show wholesale prices rose 7.4 percent in December, compared with 9.11 percent in November, a sign that seven interest-rate increases last year are taming price pressures. The nation’s 10-year bonds yield 8.23 percent, 83 basis points more than the inflation forecast. China has so- called real interest rates of minus 70 basis points, while South Korea’s are minus 41.

“Indian investors’ sacred affinity toward gold will be tested by factors like real interest rates and investment opportunities in other assets,” Ritesh Jain, the Mumbai-based head of investment at Canara Robeco Asset Management Ltd. that oversees $1.3 billion, said in an interview yesterday. “Demand for gold in India may fall 25 percent to 30 percent in 2012.”

Borrowing Costs

The metal was being perceived as a hedge against inflation through last year, Jain said, as increases in wholesale prices held above 9 percent for 12 consecutive months through November. This was especially so in rural India, where banking facilities “continue to be dismal,” he said.

Funds that buy gold managed 2 percent of total assets invested by India’s investors in mutual funds at the end of December, compared with 20 percent overseen by those that trade in bonds due in less than 12 months. Debt securities with maturities longer than a year accounted for 49 percent, while equities made up 23 percent.

The nation’s interest-rate swap market suggests that borrowing costs will decline. The cost to lock in interest rates for 12 months dropped one basis point, or 0.01 percentage point, to 7.9 percent yesterday. That’s 60 basis points below the Reserve Bank of India’s 8.5 percent repurchase rate. Goldman Sachs Group Inc. predicts policy makers will cut the repo rate by 1.5 percentage points this year, while Deutsche Bank AG estimates a one percentage point reduction.

Rupee Advances

Global funds are adding to holdings of the nation’s debt securities before the central bank reviews borrowing costs on Jan. 24. International investors bought more rupee-denominated notes than they sold for a seventh consecutive trading day on Jan. 10, boosting their ownership this month by $1.8 billion to $27.8 billion, according to exchange data.

The purchases are spurring a rally in government bonds and the rupee. Yields on the nation’s benchmark 8.79 percent notes due in November 2021 have slumped 32 basis points this year after increasing 65 basis points in 2011. The yield rose two basis points to 8.25 percent yesterday, according to the central bank’s trading system.

The rupee, Asia’s worst-performing currency last year following a 16 percent slide, gained 0.6 percent yesterday to 51.585 per dollar, according to data compiled by Bloomberg. The currency has strengthened 2.9 percent in 2012, the best performance among the region’s 10 most-traded currencies.

Gold Slumps

Gold for immediate delivery, which gained 10 percent in 2011, has slid 14 percent after touching a record $1,921.15 an ounce on Sept. 6 and traded at $1,656.88 in Mumbai yesterday.

Imports of the metal may decline to 150 metric tons in the three months through March, from 286 tons a year earlier, as the rupee’s 2011 decline boosts prices, Prithviraj Kothari, president of the Bombay Bullion Association, said in an interview.

“If gold were to correct, especially in the near term, and the rupee were to remain sideways, it wouldn’t augur very well for the investor,” Lakshmi Iyer, head of fixed income and products in Mumbai at Kotak Mahindra Asset Management Co. that oversees $5.7 billion, said in an interview on Jan. 11. “Sentiment is biased toward investing in fixed income over any other asset class for now.”

The cost of protecting the debt of State Bank of India, which some investors consider a proxy for the nation, is climbing as Europe’s debt crisis dims the allure of emerging- market assets.

Cultural Factors

Credit-default swaps on the lender cost 392 basis points yesterday after touching a two-year high of 405 on Jan. 9, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in privately negotiated markets. The swaps pay the buyer face value for the underlying securities should a company fail to adhere to its debt agreements.

With Europe’s sovereign-debt crisis spreading “like a plague,” gold will continue to attract investment in 2012 because of its appeal as a haven, according to Reliance Capital Asset Management Ltd.

Demand will also be supported by cultural factors as gold is an important part of family occasions in India such as weddings, Sundeep Sikka, the Mumbai-based chief executive officer at Reliance Capital, said in an interview on Jan. 6. Hindus, who account for about 80 percent of the nation’s population, also consider buying gold auspicious during religious festivals.

‘Extremely Bullish’

“Demand for physical gold has always been strong in India,” Sikka said. “The current global macroeconomic environment is very conducive for higher gold prices. The fundamental outlook for gold remains extremely bullish.”

Slowing growth in Asia’s third-biggest economy will damp demand for bullion, according to Canara Robeco’s Jain.

Sales of passenger cars in the nation fell almost 7 percent from November to 159,325 units last month, according to data from the Society of Indian Automobile Manufacturers. Gross domestic product will rise about 7 percent in the year ending March, Prime Minister Manmohan Singh said on Jan. 8, less than a prediction of 7.5 percent he made in December.

India’s bonds have returned 1.2 percent this month, the best performance among 10 Asian local-currency debt markets monitored by HSBC Holdings Plc. The difference in yields between rupee-denominated notes due in a decade and similar-maturity U.S. Treasuries has narrowed 31 basis points in January to 631.

“With easing of inflation, people aren’t thinking of buying gold,” Chirag Mehta, Mumbai-based fund manager at Quantum Asset Management Company, a unit of Quantum Advisors Pvt. that manages about $1.1 billion, said in an interview yesterday. “Investors are thinking that bond yields have peaked and it’s a good time to invest in government bonds.”

Source: http://www.bloomberg.com/news/2012-01-12/bonds-beating-gold-for-funds-on-slower-inflation-india-credit.html

Mark to market losses lead to YoY decline in mutual fund assets

The Indian mutual fund industry's year-on-year (YoY) assets fell over 2% in 2011 to Rs 6.11 trillion as of end December 2011, due to mark to market losses in the equity category, despite net inflows of Rs 197 billion over the year, according to a study by ratings firm Crisil. This was the second consecutive year of decline in assets with the industry having logged a 6% (YoY ) decline as of December 2010. The decline in the previous year was on account of net outflows of Rs 907 billion from mutual funds.

For the calendar year 2011, assets of equity funds fell around 23% following mark to market losses in the underlying markets where the benchmark S&P CNX Nifty was down by over 24% in the year. Despite this trend, equity funds witnessed net inflows of around Rs 77 billion in 2011. In 2010, equity funds' assets had risen over 5% to Rs 2.08 trillion on the back of mark to market gains despite net outflows of over Rs 158 billion in the category. The S&P CNX Nifty had risen around 18% in 2010.

Source: http://economictimes.indiatimes.com/markets/stocks/market-news/mark-to-market-losses-lead-to-yoy-decline-in-mutual-fund-assets/articleshow/11464609.cms