Ultra Short Term Funds invest in short-term debt instruments which means, the fund manager diversifies into a portfolio of fixed income instruments that have a maturity of one year. Thus, these funds are less affected by changing interest rate scenario in comparison to long term bonds and are suitable for investors with idle cash with a short time horizon of up to 3 months.
Considering the high interest rates that prevail in the market and the historical upward yields (see Chart 1), we interviewed Co-Fund Manager of DWS Ultra Short Term Fund, Mr. Kumaresh Ramkrishnan. This fund is also featured in our Recommended Funds section.
DWS Ultra Short Term Fund (DWS UST) is an open ended debt fund. It invests into a mixture of short-term debt and money market instruments in order to provide stable returns to the investors keeping in line with the fund’s objective.
Key Points from the Interview
Factors affecting Fixed Income in 2011
Strategies for retail investors
Impact of current market situation on bond yields
Chart 1: DWS UST Historical Yield (%)
Source: DWS Investments
Niketa Agarwal (NA): What is the outlook for fixed income in 2011?
Kumaresh Ramkrishnan (KR): The outlook for fixed income in 2011 is determined on the co-existence of three variables:
Liquidity has the greatest impact among all the three variables. The cash in the system was reduced owing to the 3G auctions. Post the auctions, the liquidity failed to ease unlike the market expectations. Moreover, the unexpected tightened liquidity has this time around coincided with rising inflation. The banks responded slowly to this rising inflation with low hikes in deposit rates in comparison to credit growth rate. The wide gap between deposit and credit growth rates, in turn, has exerted pressure on the liquidity.
- Interest rates
The banks also, are supposed to maintain the high deposit rates till inflation declines and real returns are on par with RBI guidelines. Therefore, as the inflation today is still at 8%, the retail deposit rates need to be at 9% in order to maintain a positive differential. As a result, we expect higher deposit rates with lower credit growth rates.
The government cash balance is also not in equilibrium and the expected spending in March and April would help ease liquidity. Overall, the ‘liquidity’ represents a positive impact in April and would abate in 2012 quarters.
The RBI has also raised their inflation estimates in their current policy reviews. Following factors are linked to the rise in inflation:
- Demand and Supply
- Seasonal factors which raised food prices.
As a reaction to these factors, RBI has increased its policy rates eight times. While comparing the components of inflation, RBI is concerned more about the rising non-food inflation. But, in case of the food inflation, the prices are dependent on various factors like high input costs. All this could result in further rate hikes by RBI. Inflation is also largely dependent on crude as India exports majorly, in order to meet its needs. Therefore, higher crude prices result in higher WPI thus, fuel inflation. Higher oil prices would also result in higher subsidies, which translate to higher fiscal deficit and higher borrowing, leading to rising rates. Overall, ‘crude’ remains the key variable affecting inflation and RBI would continue the calibrated rate hike in order to check inflation.
Lastly, a cautious attitude needs to be adopted for long end. This is done keeping in mind the amount and the schedule of borrowing of the government however, it is better than expected by the market. This is said, assuming there is no one off items for FY 2012 and the tax rates remain buoyant for FY 2011-12. At the end, we have a balanced budget with crude acting as variable and we adopt a cautious attitude on long term and positive attitude for short term of the yield curve.
NA: Given the view on inflation what would be the impact on bond markets?
KR: With continuous rate hikes in fiscal 2011 by RBI in order to check inflation the larger part of the tightening cycle is over although, few rate hikes would still happen.
The whole tightening cycle would ultimately, result in greater effective tightening and with an increased demand pressure, the tightening cycle would continue. Against this base, the bond market has factored rate hikes. This is also due to RBI guidelines which follow a calibrated approach, focusing on checking inflation coupled with unharming growth rate.
Therefore, we expect calibrated rate hikes by the central bank with long-term market instruments reacting cautiously to this and the short term instruments exhibiting a steep curve providing good returns.
NA: Factors such as Oil prices and liquidity crisis seem to drive the sentiments right now. Do you foresee these factors directing the movement of bond yields? What would be the impact on fixed income funds?
KR: The rise in bond yields is contributed to:
- Macroeconomic factors
- Policy rate hikes by RBI
The curve displays a flat or inverse relationship which is also due to high liquidity. In the next fiscal, with eased liquidity, we expect a steep curve starting from short end.
As a result, investors could prefer short-term funds like the money market funds to take advantage of elevated yields. Investors could also favour close ended funds i.e., the FMPs having maturity from 3months to 12-15 months to cushion the impact of rising interest rates and volatility. The money markets in FY2011-12 would continue to do well proving to lure the investors. Apart from FMPs, the short-end and short duration funds would lure investors in FY2011-12.
NA: Within the fixed income space, where do you see the greatest value for retail investors? What strategies would you suggest?
KR: The greatest value for retail investors within the fixed income space would be from the short-end of the curve because of the positive outlook on liquidity (as the tightening would lessen which in turn) would result in steep curve.
The investors can look at liquid plus and liquid categories in addition to FMPs which would do well. Apart from this, short duration fund like DWS Ultra Short Term Fund having maturity of 7 months to 12 months would be promising.
NA: What is the outlook on duration funds? Should investors enter Gilt and Income Funds now?
KR: There have been few positives on Gilt and Income Funds over few weeks:
- The projected fiscal deficit by the government for FY2011-12 is better than FY2010-11
- Better borrowing program than anticipated by the market
- Proper spacing in the borrowing calendar issued by the RBI signaling higher government spending.
However, Gilt and Income Funds are dependent on macro economy and have correlation with overseas factors like:
- Crude Oil
- Geopolitical tensions
which would impact the long term portion of the curve.
Therefore, we maintain a cautious outlook towards Gilt and Income Funds waiting for a new benchmark to be released sometime soon in April.
About DWS Ultra Short Term Fund
Mr. Nitish Gupta is the fund manager who has been managing this fund since January 2011 and has over 15 years of experience in fund management, trading and research.
Mr. Kumaresh Ramkrishnan the co-fund manager of DWS Ultra Short Term Fund has been managing this fund since January 2011 and has over 12 years of experience in Fixed Income market as Fund Manager and Analyst.
Crisil Liquid Fund Index forms the benchmark of this fund and has been rated AAAf by CRISIL.
DWS UST Portfolio allocation & performance
Chart 2: DWS UST Asset Allocation (%)
Source: DWS Investments
Chart 3: Performance Comparison (%)
Source: DWS Investments
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