AIG Short Term Fund, one of the best performing funds in the short-term category for 2011, has been continuing its good innings this year as well. The fund, which had aggressively reduced its average maturity in line with the Reserve Bank of India's (RBI) hawkish stance recently changed its gears and started increasing the average maturity to 1.1 years and 1.6 years in the months of June and July 2012, respectively. During this time, RBI, after following a tight monetary policy since 2010, suddenly took a U-turn in its Annual Monetary Policy review held in April 2012 and cut the policy rate by 50 bps. Since then the Central Bank has thrown the ball in the government’s court and is expecting some kind of response from North Block.
AIG Short Term Fund is currently managed by Vikrant Mehta who took over the reins of this fund in November 2009.Mehta is known to be a discreet fund manager but the impressive corpus that the fund has garnered in a span of six months is forcing people to take note of his fund management style. The corpus of AIG Short Term Fund has grown by a whopping 532% since February 2012 which clearly indicates that the fund manager is actually putting his preaching to practice and wants to ensure that his investors have a good night’s sleep without having to bother about their investments.
We caught up with Mehta to know his views on the markets and the reasons for changing the strategy of his fund. The fund manager started the conversation by first taking us through what has been happening in the fixed income market and the potential impact of these events in the short to medium term.
The Fund Manager is of the view that since end June 2012, liquidity was within the RBI’s comfort zone as can be seen from the Liquidity Adjustment Facility (LAF). LAF essentially refers to the amount which banks borrow from the RBI to meet their day-to-day mismatches. However, if one were to also take into account bank investments in mutual funds, the system is already in a surplus mode.
The second point he touched on was regarding the decision of the central bank to increase the FII limits in government securities by USD 5 billion to USD 20 billion on June 25, 2012. Hence, early July 2012, when the government conducted the auctions, there was a good amount of participation from the foreign investors as can be seen from the cumulative limits of INR 40,000 crore that were availed. Furthermore, the scheduled monthly FII debt auction held on July 20,212 attracted additional bids of around INR 15,000 crore. Mehta is of the view that there will be further improvement in systemic liquidity with the actual flow of the availed FII limits. He refers to this demand from FIIs as captive investor demand which he thinks is going to support bonds in the short to medium term space.
The first quarter monetary policy review guidance released on July 31, 2012 mentioned that managing liquidity within the comfort zone remains an objective and the RBI would respond to liquidity pressures, including by way of Open Market Operations (OMOs). Mehta was of the view that while RBI’s action was in line with market expectations; the current surplus liquidity was unlikely to result in OMOs in the near term. However the expiry and delivery of forward sale contracts of dollars conducted by the RBI in the recent past could result in OMOs by RBI to contain liquidity pressures, thus keeping bond yields in check.
The biggest game changer for the fixed income market, according to the fund manager, is the discomfort of the government on the reliance of banks on wholesale deposits. This could lead to a demand/supply mismatch for certificate of deposits (CDs). In short, this means that the surplus with wholesale investors could lead to inflows into mutual funds at the expense of bank fixed deposits which could further drive up the demand for CDs.
Going forward, Mehta is of the view that the CD yield curve, which used to be flattish or inverse, is turning into a normal sloping yield curve. He is of the opinion that when valuation norms are going to change for debt instruments with a maturity of around 60 days, the CD yield curve will steepen and could trend lower. Potential demand spillover on account of lesser CD issuance, probable normalization of flat/inverse corporate credit yield curve on improved liquidity and FII demand could generate demand in credit space. In short, the fund manager is of the view that all the factors mentioned above will create more demand for bonds in the short to medium term space and this is the reason for adding duration to the portfolio along with taking exposure to AAA bonds in the short term.
In addition to this, we posed three questions to the fund manager. His answers are reproduced here.
- Interest rates: Have they peaked or is some steam still left in them?
I am of the view that rates peaked in the month of April 2012.The overhang of the large FY 2012-2013 borrowing program amidst tight liquidity conditions led to a sell-off in the government bond market. What really surprised the market was that the RBI conducted OMOs in the month of May, while the market expected it to be done in the second half of the financial year.
- What is the debt market favoring: Long or short term?
We are of the view that in the current market environment, the central bank has already front loaded rate cuts in April and is now maintaining a status quo on that front. In this scenario, it would be advisable to look at our short term fund or even funds in the dynamic space.
- Active or Passive: Which fund management style is better?
We have done a study* whereby we have tried to find out the attractiveness of active v/s passive investment strategies in the fixed income market. Since time is a constraint, I will just sum up the conclusion of the above study –“The active investment strategy as represented by AIG Short Term Fund outperformed the passive investment strategy. In this case we considered a generic certificate of deposit, overa 3 months-12 months time horizon”.
*Investors can access the above study on our website:
Fundsupermart.com’s take on the fund…
We are of the view that the change in strategy of the fund since the last 2 months, in terms of both, duration and portfolio composition, is in the right direction. We recommend this fund to all those investors who do not want to take exposure into different fixed income options depending on the direction of interest rates; however let the fund manager who has the expertise do that for them. We advise all investors who enter into this fund to stay in for atleast 6 months to 12 months so that the teams at AIG have ample time to play out their strategies without investors being bothered about their surplus that has been parked in this fund.
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