fixed income - investment strategy - november 2011

7/31/2019 Fixed Income - Investment Strategy - November 2011

1/20

Fixed Income - Investment StrategyOdds in favor

Private & Confidential

November, 2011


2/20

Synopsis

RBI tightening is finally beginning to hit growth

Depreciating rupee is setting off the benefit from falling commodity prices

Higher base for Inflation to help lower inflation going forward

Government to find difficult to meet deficit target of 4.6% - already priced in


y t e on mar et

Currently 10 yrs G-sec yield has shot up to ~9.00% which seems to be very

close to its peak if not peaked already

We expect a reversal of this trend and that yields should start falling

Under the given circumstances we have devised two investment strategies that

can be looked at


3/20

Current Scenario


Inflation still close to double digits

Moderating growth is raising concerns


4/20

Inflation remains near double digits

Depreciating rupee sets off the benefit from

falling commodity prices

Inflation remains sticky with no signs of price correction

in any of the broad categories, i.e. primary, fuel and

manufacturing

Correction in global commodity prices not getting

reflected in India due to depreciation of the rupee

WPI inflation remains near double digits in Oct 11

122

127

132

137

142

147

152

157

r-09

ul-09

t-09

n-10

r-10

ul-10

t-10

n-11

r-11

ul-11

t-11

(Wholesalepriceindex)

-2

0

2

4

6

8

10

12

(WPIinflation,%)


Source: RBI

A J O J A J O J A J O

WPI WPI inflation (RHS)

Source: RBI

Non-food manufactured products index is flattening

123

125

127

129

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133

135

137

Apr-10

May-10

Jun-10

Ju

l-10

Aug-10

Sep-10

Oct-10

Nov-10

Dec-10

Jan-11

Feb-11

Mar-11

Apr-11

May-11

Jun-11

Ju

l-11

Aug-11

Sep-11

Oct-11

(Non-foodManufacturingprices,index)

Source: RBI

Food inflation stabilizing, but at higher levels

-6

-3

0

3

69

12

15

18

21

Apr-09

Jul-09

Oct-09

Jan-10

Apr-10

Jul-10

Oct-10

Jan-11

Apr-11

Jul-11

Oct-11

(Inflation

,%)

Food Non-food


5/20

Moderating growth, rising concerns

RBI tightening is finally beginning to hit growth

Contraction of mining and high interest costs weighing

down industrial production growth (1.9% in Sep 11)

Eight core industries grew at their slowest in 31

months at 2.3% in Sep 11; coal, natural gas andfertilizers production contracted in September

India's manufacturing activity in October expanded--

though modestly--indicating an improvement in business

conditions from a month ago as growth in new orders

Industrial growth at 1.9% in Sep 11

-10

-5

05

10

15

20

25

Jul-07

Oct-07

Jan-08

Apr-08

Jul-08

Oct-08

Jan-09

Apr-09

Jul-09

Oct-09

Jan-10

Apr-10

Jul-10

Oct-10

Jan-11

Apr-11

Jul-11

(Gro

wth,%)


0

2

4

6

8

10

Sep-08

Jan-09

May-09

Sep-09

Jan-10

May-10

Sep-10

Jan-11

May-11

Sep-11

(Growth,yoy,%

)

Core sector growthSource: Bloomberg.

Core sector growth at the slowest in 31 months

Source: GOI

Manufacturing activity expanded in Oct 11

44

47

50

53

56

59

62

Apr-06

Sep-06

Feb-07

Jul-07

Dec-07

May-08

Oct-08

Mar-09

Aug-09

Jan-10

Jun-10

Nov-10

Apr-11

Sep-11

(PurchasingManagerIndex)

India manufacturing PMI

Expansion

Contraction

Source: GOIIIP (wt 100) Manufacturing (wt 75.5)


6/20

Our View


RBI to pause rate hike

Markets factoring possible high Fiscal deficit


7/20

RBI hiked the rate but hinted a pause ahead

Higher base for Inflation to come to the rescue

RBI Hiked policy rated by 25 bps in October 2011.

however, at the same time it also hinted at a pause on

the sharpest monetary tightening cycle

We expect Inflation to be at current levels in Oct-Nov11 and to fall sharply to ~8% in Dec11-Jan12, due to a

strong favorable base. Our Mar12 inflation target is

~7.5%

Sharpest monetary tightening in any tightening cycle

3

4

5

6

7

8

9

Oct-0

5

Feb-06

Jun-

06

Oct-0

6

Feb-07

Jun-

07

Oct-0

7

Feb-08

Jun-

08

Oct-0

8

Feb-09

Jun-

09

Oct-0

9

Feb-10

Jun-

10

Oct-1

0

Feb-11

Jun-

11

Oct-1

1

(Policyra

te,%

)

Reverse Repo Repo Rate


Source: RBI

Reducing gap between core inflation and repo rate

Source: RBI

Inflation likely to soften to 7-7.5% by Mar 12

Source: RBI

-2

0

2

4

6

8

10

12

Apr-05

Oct-05

Apr-06

Oct-06

Apr-07

Oct-07

Apr-08

Oct-08

Apr-09

Oct-09

Apr-10

Oct-10

Apr-11

Oct-11

Apr-12

(Inflation,%)

WPI inflation Estimates


8/20

Markets factoring possible high Fiscal deficit

Difficult to meet deficit target of 4.6%

In first half of FY12, fiscal deficit has already reached

71% of the budget target for the full year FY12

Target of 4.6% budget deficit seems too challenging to

meet as the slowdown would affect revenues

Government may have to borrow additional Rs 500bn

to meet the shortfall from the revenue side; bond

market already factoring in the slippage on the fiscal

front

Fiscal deficit at 71% of FY12 target in first half of FY12

41.4

74.9

44.2

33.2

27.8

47.6

70.8

76.0

40.5

36.6

0 10 20 30 40 50 60 70 80

Net tax revenue

Non-tax revenue

Expenditure

Fiscal deficit

Revenue deficit


5.0

5.5

6.0

6.5

7.0

7.5

8.08.5

9.0

9.5

10.0

Ap

r-08

Jul-08

Oct-08

Jan-09

Ap

r-09

Jul-09

Oct-09

Jan-10

Ap

r-10

Jul-10

Oct-10

Jan-11

Ap

r-11

Jul-11

Oct-11

(10yearg-secyield,%)

Source: GOI

Corporate tax remains a laggard

Source: Bloomberg and Anand Rathi Research.

Expectations of more govt. borrowing pushed the yields ~9%

Historically, government usually spends more in thefirst half while revenues pick up in second halfSource: GOI

(% of full year target) 1HFY11 1HFY12

0

200

400

600

800

1,000

1,200

1,400

Income tax Corporate tax Custom duties Excise duties

(Rsbn)

1HFY11 1HFY12


9/20

Investment Opportunity


Strategy 1: Capital Gains

Strategy 2: Interest Accrual


10/20

10 Yr Benchmark G-Sec is at peak levels

Investment Rationale

We expect inflation to decline to ~7.5% by Mar12 on account of higher base

and the impact of monetary tightening getting reflected in the system

If growth remains sluggish RBI might consider a rate cut around Q1 of FY13

Also, any collapse of the financial system in the Euro zone would result in

reserve banks cutting down policy rates to keep economies afloat

-

Strategy 1 Capital Gains(-) Risk (+)

(-)Return

(+)


-

~9.25% and then start softening towards its historical mean (~7.50% - 8.00%)

Recommendation

The rallies in G-sec markets can be sharp and can come very rapidly. Since

2002 we have seen that the 10 Year benchmark G-sec has spent more time

below YTM of 7% than above 9%. Moreover, it is difficult to time the market

and catch the peak.

We suggest investors looking for a medium risk - high return^ opportunity to

start allocating a portion of their debt portfolio towards G-Sec funds in a

staggered manner over a 2-3 month period, with an investment horizon of

12-15 months

50 Days

738 Days202 Days

^ Refer appendix - Reading the risk-return grid


11/20

Strategy 1 - Gilt Funds - Actively Managed

Top 5 picks

Scheme Name Age (yrs) AUM Crs 1M 3M 6M 1YR 2YR 3YRAvg Mat

(Yrs)Cash (%) Duration

Kotak Gilt Investment 12.28 45.80 3.39 7.58 6.52 5.34 5.65 9.05 10.00 N.A. 6.50

ICICI Pru Gilt-Invest PF(G) 12.22 221.18* (10.72) (0.79) 2.57 3.72 3.91 6.61 7.00 31.33 4.70

Birla SL G-Sec-LT(G) 11.98 381.72* (6.67) (0.15) 2.85 3.74 6.87 11.77 7.50 23.47 5.35

HDFC Gilt-LT(G) 10.29 160.46* (12.65) (2.20) 2.00 3.16 4.34 4.88 8.60 5.77 5.00


Note:

Funds with AUM more than Rs.40crores are only selected

Funds with a track record of more than 3 years

Data Source: ACE MF and AMCs

* as on Sep-11

UTI Gilt Adv-LTP PF(G) 9.78 125.76* (15.04) (1.16) 3.90 5.21 4.84 4.95 7.35 34.22 5.25


12/20

Strategy 1 - Gilt Funds - Passively Managed

Investment Rationale

Asset Allocation

Security Investment

10 Year Benchmark G-Sec 90 100 %

Other Government Securities (7 to 12 years),

T-Bills, Cash Management Bills, CBLO & Repo0 10 %

Type of the scheme: An Open Ended Gilt Scheme

Two Plans: Dividend & Growth

Fund Manager: Abhiroop Mukherjee

B.com (H), MBA 4yrs Experience in Trading Fixed Income

Securities viz. G-Sec, T-bills, Corporate Bonds CP, CD etc. Earlier

worked with PNB GILTS LTD. as WDM dealer for 2007-2011

Fund Details

Motilal Oswal MOSt 10yr Gilt Fund


Note:

For further details, please refer to the Scheme Information Document (SID)

Replicates the 10 year G-Sec benchmark returns

Defined mandate of the fund

High Liquidity and denominations can be smaller

Good investment for investors willing to take a call on

government securities

Total Expenses: 0.99%

Exit Load: 0.5% if redeemed within 3 months

Min Subscription: Rs.10,000 & in multiples of Re. 1 thereafter

NFO Opens: 21st November 2011

NFO Closes: 5th December 2011


13/20

Strategy 2 Interest Accrual(-) Risk (+)

(-)Return

(+)

Flat Yield Curve, good accruals on short term

Existing yield curve is flat. It is in a very narrow

range of 8.50% - 9.00%

This makes the accruals on the shorter end of

the yield curve attractive as compared to the

longer end

6.50

7.00

7.50

8.00

8.50

9.00

onths

onths

1Year

2year

3Year

4Year

5Year

6Year

7Year

0Year

1Year

2Year

3Year

4Year

3-Nov-2011

Current Scenario:

Flattish yield curve

Yield


,

there is some scope for capital gains.

However, due to low duration on the short-end,

either capital gain or loss will be negligible over

small movements in yields

We suggest our clients to invest in Short-term

income funds with an investment horizon of 3-6

months

3 61

1

1

1

1

6.50

7.00

7.50

8.00

8.50

9.00

3Months

6Months

1Year

2year

3Year

4Year

5Year

6Year

7Year

10Year

11Year

12Year

13Year

14Year

3-Nov-2010 3-Nov-2008

Note: for Maturities where data was not available Yield has been assumed to be average yield of the immediate next and previous maturities available

Past Scenario:

Normal yield curve

Yie

ld

Tenure

Tenure

^ Refer appendix - Reading the risk-return grid


14/20

Strategy 2 Short-Term Bond Funds

Top 5 picks

Scheme NameAge

(yrs)AUM Crs 1M 3M 6M 1YR 2YR 3YR

Avg Mat

(Yrs)

Yield to

MaturityAAA/P+ Cash

Kotak Bond-STP(G) 9.52 980.08 6.69 7.58 8.68 6.65 5.86 8.48 1.50 10.10 81.99 4.83

UTI ST Income(G) 8.36 223.25* 7.61 8.47 9.54 8.83 7.43 8.06 2.34 9.75 51.60 3.88

Templeton India ST Income(G) 9.76 4415.59* 8.51 8.84 9.39 8.16 7.40 9.52 0.80 9.98* 64.72 1.43


Note:

Funds with AUM more than Rs.200crores are only selected

Funds with a track record of more than 3 years

Data Source: ACE MF and AMCs

* as on Sep-11

DWS Short Maturity-Reg(G) 8.78 575.34* 7.66 8.90 9.28 7.90 6.68 9.38 1.00 10.17 70.40 4.54

ICICI Pru STP-Ret(G) 10.02 652.59* 8.23 8.61 9.02 7.54 6.20 9.25 1.68 9.92* 63.63 3.75


15/20

Appendix


Glossary

Tax Reckoner

Risk-return grid


16/20

The Yield to maturity (YTM) of a bond or other fixed interest security, such

as gilts, is the internal rate of return (IRR, overall interest rate) earned by an

investor who buys the bond today at the market price, assuming that thebond will be held until maturity, and that all coupon and principal payments

will be made on schedule. Yield to maturity is actually an estimation of future

return, as the rate at which coupon payments can be reinvested when

received.

Key Terms Glossary


The duration of a financial asset that consists of fixed cash flows; It is theweighted average of the times until those fixed cash flows are received.

Duration also measures the price sensitivity to yield, the percentage change

in price for a parallel shift in yields

Modified Duration is a formula that expresses the measurable change in the

value of a security in response to a change in interest rates


17/20

Tax Reckoner 2011-2012

Individual/ HUF Domestic Company NRI*

Tax Implications on Dividend received by Unitholders

Dividend

Equity oriented schemes Nil Nil Nil

Debt oriented schemes Nil Nil Nil

Tax on distributed income (payable by the scheme) rates effective from 1st June 2011

Equity oriented schemes ** Nil Nil Nil

Debt schemes12.5% + 5% Surcharge + 3%

Cess= 13.519%

30% + 5% Surcharge + 3%

Cess = 32.445%

12.5% + 5% Surcharge + 3%

Cess= 13.519%

Money market and Liquid schemes25% + 5% Surcharge + 3%

Cess= 27.038%

30% + 5% Surcharge + 3%

Cess = 32.445%

25% + 5% Surcharge + 3%

Cess= 27.038%

Capital Gains Taxation

Long Term Capital Gains (Units held for more than 12 months)


Equity oriented schemes ** Nil Nil Nil

Other than equity oriented schemes

10% without indexation or

20% with indexation

whichever is lower + 3% Cess


20% with indexation


+ 5% Surcharge


20% with indexation


Without indexation 10.3000% 10.8150% 10.3000%

With indexation 20.6000% 21.6300% 20.6000%

Short Term Capital Gains (Units held for 12 months or less)

Equity oriented schemes ** 15% + 3% Cess = 15.45% 15% +5% Surcharge + 3% Cess= 16.223%

15% + 3% Cess = 15.45%

Other than equity oriented schemes 30% + 3% Cess^ = 30.9%30% +5% Surcharge + 3% Cess

= 32.445%30% + 3% Cess^ = 30.9%

*The short term/long term capital gain tax will be deducted at the time of redemption of units in case of NRI investors only.

** STT @ 0.25% will be deducted on equity funds at the time of redemption and switch to the other schemes.

Mutual Fund would also pay securities transaction tax wherever applicable on the securities bought / sold

^ Assuming the investor falls into highest tax bracket.


18/20

Reading the Risk-Return grid

(-) Risk (+)

(-)

Return

(+)

(-) Risk (+)

(-)Return

(+)

(-) Risk (+)

(-)

Return

(+)

(-) Risk (+)

(-)

Return

(+)

(-) Risk (+)

(-)Return

(+)

(-) Risk (+)

(-)Return

(+)

Low Risk, High

Return

Low Risk, Average

Return

Average Risk, High

Return

Average

Risk, Average Return

High Risk, Average

Return

High Risk, High

Return


(-) Risk (+)

(-)Return

(+)(-) Risk (+)

(-)Return

(+)(-) Risk (+)

(-)Return

(+)

Low Risk, Low

Return

Average Risk, Low

Return

High Risk, Low

Return

Note:

1. Risk & return assessment based on qualitative analysis2. Risk & Return are relative to the Asset Class


19/20

Rateo

fReturn

Sectoral Equity Funds

Balanced Funds

Diversified Equity Funds

Reading the Risk-Return grid


Money market FundsAverageAnnua

l

Risk (Standard Deviation)

Short Term Bond Funds

Gilt/Income Funds

s


20/20

fixed income - investment strategy - november 2011

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