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Key Investment Themes for 2011-India Perspective
January 3, 2011

Key Investment Themes for 2011 from India Perspective

Author : iFAST Research Team

Untitled Document

Debt Market Scenario

Rising interest rates

The Reserve Bank of India (RBI) increased the Repo Rate and Reverse Repo Rates by 150 basis points and 200 basis points (bps) respectively in 2010. The monetary tightening was an outcome of inflationary pressures from domestic side as well as global factors.  

Going ahead, RBI may find it difficult to meet the inflation target of 5.50% by March 2011 and inflation would persist for some time.Hence, we expect that the Central Bank would increase Repo and Reverse Repo rates further by 50 bps in the first three months of 2011.

Although inflation is a major concern now, we are of the opinion that the inflation data will show moderation in the second half of 2011 on account of good monsoon and base effect. In addition, we also expect the growth in the economy to moderate next year, FY 2011-12, which will make the Central Bank to go in for a pause in the rate hikes in the second half of 2011.

Chart 1: Policy Rates

Liquidity crunch

At present, Indian debt market is facing huge liquidity crisis. In the month of November and December, banks have been borrowing daily, on an average, more than INR 1 trillion and INR 1.2 trillion respectively from RBI.

The liquidity crunch has been on account of following factors:

  1. Large Government surplus averaging INR 840 billion gained from 3G auction and buoyant tax collections that has been lying with the RBI since the second quarter review of November 2010
  2. Huge equity issuance in the form of Initial Public Offering and Follow on Public Offers and 
  3. Sluggish growth in bank deposits despite the accelerating credit growth

We expect that liquidity to remain tight for some more time, but in the run up to March 2011, the borrowing of the government for FY 2010-11 will be completed and the huge government surplus lying with the RBI will be infused into the economy in form of government expenditures. These factors should ease the short-term and long-term rates.

The Union Budget FY2011-12 would have a significant impact on fixed income markets in 2011. Several factors such as the borrowing calendar of the government along with the fiscal deficit roadmap and the disinvestment plans for 2012 will be the crucial factors that would decide the movement of bond yields.


High Yields

Due to the six continuous rates hikes by the Reserve Bank of India (RBI) in 2010 and the severe liquidity crunch faced in the system since the last few months, the bond yields have increased sharply.  In the last 18 to 20 months, yields on the short-end and the long-end of the curve have significantly moved higher. On the 10 year G-Sec paper, the yields have risen by 180 basis points (bps) and on the Certificate of Deposits of time period between 3 and 12 months, the yields have risen by 400 to 500 bps. The yields on 3-12 months Commercial Papers have also risen by 400 to 550 bps.

FII limits eased

 The FII limit in the bond market has been increased to US$30 billion and the impact of this measure would be seen in 2011. The increased FII limit will definitely help in easing the liquidity situation in the market. The FII inflows into the Indian market are approximately US$9 billion (Year-to-Date) as against US$1 billion in 2009.

Chart 2: Yield of Various Debt Securites

 Implication for Investors

Fixed Maturity Plans

  • expects the short-term rates to go down in the second half of 2011 with RBI going slow on rate hikes and easing of liquidity. In this scenario, it would be advisable for investors  to lock in money in Fixed Maturity Plans (FMPs) as they can take advantage of prevailing high yields. Plus, there is negligible impact of interest rate movements as the portfolio is held till maturity.  In addition, they are tax efficient, as they are taxed at 10% without indexation and 20% with indexation.  Thus, the returns given by the FMPs post tax would be more than net yield from Fixed Deposits. There is also double indexation benefit, if investments overlap 2 financial years. Thus, investors having a time horizon of 3 months to 2 year time horizon can consider Fixed Maturity Plans (FMPs).

Ultra Short Term Funds

  •  Investors whose money idles in their savings account for over a month can consider Ultra Short Term Funds as an alternative. The return earned on a savings account is only 3.5% per annum, while for Ultra Short Term Funds, an average return falls in the range of 4.5%-5% or at times even more. From taxation side, the interest income from savings account is added to the individual’s income, whereas for Ultra-Short Term, the Dividend Distribution Tax is 14.16% including surcharge and education cess.
  •  Our recommended Funds in the Ultra-Short Term Funds are DWS Ultra Short Term Fund, Birla Sunlife Ultra Short-Term Fund, BNP Paribas Money Plus Fund.
Outlook on Equity
  • Neutral on Indian Equities on account of the following factors:
  • Sensex is overvalued in terms of historical and relative valuation.  Historically, the fair P/E of Sensex has been around 17X, whereas we are currently trading above the historical levels. Expected EPS of Sensex by March 2011 is around 996 which translate into a P/E of 19.94X.
  •  Year-to-Date (as at 30 November 2010), FIIs have already pumped in around US$ 28.91 billion into Indian Equity market.  Any reversal in the FII inflows due to the uncertainty in the global economy could severely impact the Indian market.
  • The huge FII inflow has led to Rupee Appreciation, which has reduced the attractiveness of Indian exports. If the Central Bank resorts to capital controls to hold the inflows, then there would be a sharp correction in the Index.
  • In the year 2010, RBI has hiked rates six times, the impact of which will be seen in terms of moderation in the GDP data in the coming quarters, which will affect the profitability of Indian corporate sector.

Implications for Investors

Mid-cap Funds

  • Investors should look at mid-cap funds as this category is expected to deliver better returns than their large cap counterparts. This is because the midcap index is currently trading 25% below its previous all-time highs. In this scenario, fund managers will definitely look out for quality stocks in the mid-cap space which are available at attractive valuations.
  •  Our Recommended Funds in the Mid-cap Funds are HDFC Mid-cap Opportunity Fund, and DSP BlackRock Small & Midcap Fund.

Infrastructure and Banking Sectors

  •  We are positive on the infrastructure and banking space. Although the infrastructure sector has underperformed in 2010 on account of reduced capital expenditure and global recession, we feel that the expected GDP of 8.70% in 2011 can be achieved only with huge spending on this sector. In the Twelfth Five year Plan (2012-2017), Government is planning to spend about US$1 trillion into the infrastructure space. If infrastructure is the favored sector with the government then it will be the banks, which will be the key financiers of the infrastructure projects. Although RBI expects credit growth to be around 20% by 2011, we are of the opinion that the figures will be higher on account of companies reviving their capital expenditure plans and higher disposable income with the masses. The credit growth as at 3 December 2010 has already reached 22%. 
  •  Our Recommended Funds for the Infrastructure and Banking Sectors are ICICI Prudential Infrastructure Fund, DSP BlackRock India T.I.G.E.R Fund and Reliance Banking Fund.

FMCG and Healthcare Sectors

  •  FMCG and Health Care sectors have outperformed BSE Sensex in 2010 and we expect these sectors to continue their outperformance in 2011 at the back of the strong consumption growth especially in the rural segment. Plus, there is growth potential in the generic market along with the consolidation that is expected in the Pharmaceutical space.
  •  Our Recommended Funds for the FMCG and the Health Care categories are  Magnum Sector Umbrella Fund - FMCG and Reliance Pharma Fund.

Global Funds

  • Since global corporate earnings are expected to hit record highs by the end of 2012, we advise investors to take exposure to global funds. Fundsupermart is of the view that the global economy will continue to recover in 2011 as well, and we are very positive on the emerging markets and believe that countries like China will be the main drivers of global economic growth. Investing in global funds is relatively new to Indian investors. Most of the Indian investors have a concentrated India portfolio largely due to the fact that mutual fund / investment offerings in the country have been centered on the domestic market. Now that more international funds have come in through the feeder funds route, we are of the opinion that entering into these funds will not only help in geographical diversification, but also reduce the overall portfolio risk.
  • Our Recommended Funds in the Global Funds categories are Mirae Asset China Advantage Fund and Principal Global Opportunities Fund.

iFAST and/or its content and research team’s licensed representatives may own or have positions in the mutual funds of any of the Asset Management Company mentioned or referred to in the article, and may from time to time add or dispose of, or be materially interested in any such. This article is not to be construed as an offer or solicitation for the subscription, purchase or sale of any mutual fund. No investment decision should be taken without first viewing a mutual fund's offer document/scheme additional information/scheme information document. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Investors should seek for professional investment, tax, and legal advice before making an investment or any other decision. Past performance and any forecast is not necessarily indicative of the future or likely performance of the mutual fund. The value of mutual funds and the income from them may fall as well as rise. Opinions expressed herein are subject to change without notice. Please read our disclaimer in the website.


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