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IDFC Mutual Fund: Inverted Yield Curve - An opportunity for investors
January 27, 2011

This is a brief outline of the conference call held on January 10, 2011 with Mr. Suyash Choudhary, Head-Fixed Income at IDFC Mutual Fund. The article covers outlook from IDFC Mutual Fund on Economy and debt market.


Author : iFAST Research Team



Untitled Document

Key Highlights

  • Overall outlook on macro-economic background negative
  • Expects inflation to hover around 7.00% in March 2011
  • Expects RBI to hike repo rate by 100bps by December 2011
  • Expects liquidity situation to ease around April 2011
  • Negative on funds following passive management of duration and does not recommend investment in G-sec funds for next 6 months or so 

Product Positioning

  • At present, the corporate bond curve is largely inverted but later in the year, expects the curve to realign to positive slope
  • Has positioned IDFC Money Manager Fund-Investment Plan around 1 year Certificate of Deposits (CDs) with a 6 month investment horizon. Average maturity of the product will be reduced as the year progresses
  • As the yield curve realigns to positive slope, the investment strategy, over a period of 6 months, should benefit the investor 

 
Overview of the Debt Market and Indian Economy

IDFC Fund House views that overall, we are in a bear market for interest rates.  Inflation remains the predominant concern of the RBI. Most of the policymakers and Government of India anticipated good monsoons to help cool down food inflation but, on the contrary, the upward trend in food inflation has resulted in offsetting the beneficial effect of monsoon’s experienced.  The prices of vegetables and proteins are rising. Overall in Asia, food inflation is a cause of concern and in the next 3-4 months, there will be little relief from food inflation, if any.

Mr. Suyash Choudhary- Head Fixed Income highlighted that the strength of private sector demand is turning out to be heavier than anticipated. Taking into consideration the last two quarters of GDP, the numbers from private sector have surprised on the upside. He also pointed out that the global commodity prices are on a two year high including oil, metals and food prices. Given all these factors, it is difficult for RBI to achieve its projected inflation target of 5.50% by March 2011. He expects inflation to hover around 6.50-7.00% in March 2011 and the average inflation rate for the year 2011- 12 at around 7.00%.

 Mr. Choudhary states that RBI will hike repo rate by 100 bps by December 2011, taking the repo rate to 7.25% from the present _6.5%____, raising rates from January 25, 2011. Overall the fund house outlook on the macro economic background is quite negative.

Liquidity

The liquidity situation in the market is slightly better than previous month.  As against a deficit liquidity environment of INR 1, 50,000 crores in December 2010, the current levels are down to around INR 70,000-75,000 crores as a result of spending by Government of India. Also, RBI through its open market operations is buying government securities. Going forward, in March 2011, the liquidity may deteriorate further on the back of advance tax outflow but by April 2011, it should get better again

Bond Yields

The fund house is quite negative on the G-sec curve as they believe that the G-sec curve was artificially held down owing to the purchase of government securities by the central bank. Since November 2010, RBI has bought around INR 60,000 crores of government securities and it is expected to buy further INR 10,000 crores. This demand was suppressing the G-sec yields but now that the demand is over, G-sec yields are correcting to new highs.

Going forward, around declaration of Union Budget i.e., till February 2011, the market will turn bearish. This is mainly due to the fiscal deficit, which is expected to be higher at 4.80-5.00% of GDP next year, will result into heavy bond supply over April-September 2011. Mr. Suyash Choudhary is quite negative on funds that are duration oriented and does not recommend investment in G-sec funds for next 6 months or so.

Corporate Bond

The corporate bond curve is largely inverted with one year CDs trading at 9.50-9.60%, three year at 8.90% and 5 year and 10 year are trading at around 9.00%. Mr. Choudhary adds that the inversion is temporary and will not sustain beyond April 2011. According to him, the primary reason for this inversion in corporate bond curve is due to extreme liquidity deficit faced by the system. Also, the incremental credit growth is around 25%; on the other hand, deposits are growing by only 15% causing interest rates to go up at such elevated levels. Starting April 2011, given the high deposit rates, money will start flowing into time deposits and the credit growth is also expected to slowdown. This would narrow down the wide divergence between credit and deposit rates. As a result, the slope of the yield curve will become positive again.

IDFC Money Manager Fund - Investment Plan

The product proposition is buying into 1 year CDs with a 6 months investment horizon. The fund has a 3 month exit load of 0.50%. The idea is that as the yield curve realigns to positive slope, the investment strategy, over a period of 6 months, should benefit the investors. The product is subjected to market risk and therefore, sensitive to yield movements. However, given the inverted yield curve and one year CD trading at 9.50% level, this fund can be looked at as a powerful investment idea.

Mr. Suyash Choudhary believes that as long as the yield curve is inverted, a fund like Money Manager Fund-Investment Plan will perform better than Income Fund or Short Term Plan because these Income funds - Short term funds usually invest in 18months to 2 year papers which are currently trading at inversion via the 1 year CDs. In the current scenario, thus, IDFC Money Manager Fund - Investment Plan Investment Plan is a strong product position.

Final words

With the bear market outlook and anticipated rate hikes by RBI, the pressure on one year rates will rebuild around September to October 2011.  Therefore, IDFC Money Manager Fund - Investment Plan will start to reduce its average maturity on incremental purchases later during this year. So by November to December 2011, the fund will start to reflect 3 - 4 months of average maturity profile. The overall investment strategy is to allow investors to participate in this fund at the prevailing high levels of one year CDs and over a period of 6-9 months, lessen the average maturity so as to reduce the Mark-To-Market volatility of the portfolio.


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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