I have been saying that there will be good opportunities of investing at long end of the curve (10 year benchmark thru schemes like AXIS CONSTANT MATURITY SCHEME & RELIANCE GILT SCHEME) in mid March post the Budget announcements where the Fiscal deficit numbers will be on the higher side. Along with that, typically there is liquidity tightness in March & State elections which will all have negative impact on the debt market. (Short term correction in a long term bull market in Debt)

In the intervening period one can either park in regular liquid plus schemes or invest in the following schemes which have much higher captured YTM due to higher exposure in CPs & which have exit loads which will match the maturity of your funds to coincide with tightness in the month of March. This way, one will earn much higher returns than liquid plus schemes & have funds in their hands to invest in long duration schemes in the tight money market period of March 2012 as discussed above.

Scheme Attributes : As On January 31’2012:

Immediate reaction of the markets was to assume that since RBI had announced CRR cut, going forward RBI will cut down on conducting OMOs. This immediately impacted the long dated securities which was evident from the intra day movements of 10 year bench mark paper. Post the CRR cut announcements, benchmark yield corrected positively & breached 8.10% for some time before finally settling at 8.35% levels.

Generally, RBI buys long dated securities under OMOs. This was evident from the rally which happened in long dated securities from December onwards when RBI started conducting OMOs. During the same period, there was hardly any movement at the shorter end of the curve of 1-3 years. Following chart will depict this very clearly:

However, I believe that, given the present level of liquidity deficit, RBI will continue with OMO auctions, giving support to the bond market as the liquidity deficit is expected to increase in the month of March due to advance tax payment, currency leakage and increased economic activity in the last quarter.

Every spike in long dated securities should be treated as an investment opportunity. I had mentioned in my note dated January 17’2012 on AXIS CONSTANT MATURITY SCHEME that debt markets will give enough opportunities from now to March end & hence had recommended investment on weekly basis in the said scheme.

GOING FORWARD: FOR IMMEDIATE ACTION:

Immediate impact of CRR cut will be felt (and is already being felt) in short to medium dated securities in 1-3 year segment.1 year CD has already rallied from 9.98% to 9.80% levels & will rally at a much faster pace once CRR cut comes into effect from Friday onwards. This is exactly what I had mentioned in my note dated January 20’2012 wherein I had talked about the positive impact of CRR cut, rate cuts,etc on the shorter end of the curve. RBI action of CRR cut has aided this process sooner than later.

I would therefore recommend investments in the schemes mentioned in my January 20’2012 dated note at the earliest (read before Friday i.e. January 27’2012)

A very interesting story is likely to unfold in 1-3 year segment on the yield curve. Most of the market participants are in consensus about a downward bias on the yields of various maturities based on various factors which I have enumerated in my last note on AXIS Constant Maturity Scheme. I have given reasons as to why going forward based on both fundamental factors & RBI intervention, yields will take a southward journey.

Consider the following figures to understand the full impact of what I am about to enumerate:

(SOURCE: RELIANCE MUTUAL FUND)

Hence, as can be observed from above, there has been a major impact on the short end of the yield curve (almost 373 bps) v/s long end of the yield curve (only 48 bps) inspite of the fact that RBI raised rates by almost 375 bps during that period. This can be partly attributed to liquidity tightness which is being witnessed over the past year or so due to various RBI actions & initiatives including CRR hike by 100 bps & partly due to FIIs pulling out of emerging markets.

All this was done to contain inflation which continued to hover above 9% levels over this period. All the efforts of RBI along with impact of base effect has brought inflation (food inflation in fact has gone negative) under 8% levels (currently 7.47%).

Hence, as mentioned above, now the general consensus is that RBI will focus on growth (which has come off significantly due to rising interest rates and other factors like global meltdown, etc) rather than inflation & announce measures which will help boosting growth once again. Some of the actions in their order of preference would be conducting OMOs to infuse liquidity (which RBI has already started doing), CRR cut & then interest rate cuts.

All the above will help in infusing liquidity & as is logical, this will impact positively the short end of the curve which was under pressure over last 2 years or so due to liquidity tightness. Also, the fact that 1 year segment had gone up by almost 300-400 bps (v/s only 50 bps on long end); this segment is very nicely poised to compress at a faster pace with RBI’s expected intervention going forward & make the yield curve steeper once again. Though, this will help compression at long end as well, the same might not be as much in terms of it’s impact as it should impact the short to medium term securities.

Hence, I would strongly recommend to invest in those short term plans which have an average maturity ranging from 1 to 3 years & which can capture the above story well. Some of these schemes which have already captured this story or are likely to capture the same  are as follows:

Update: “Pramerica Dynamic Fund” details were inadvertently published instead of “Pramerica Dynamic Bond Fund”. The NFO closed on 11 January 2012.

DISCLAIMER

As you all are aware, though trading call was given based on movements in 10 year benchmark yields, it never gets fully priced in as most of the fund managers run different average maturities based on their assessment of the market & run average maturities ranging from 5-7 years. Hence, a trading call so far, was never fully implemented in true sense of the word due to different average maturities of these schemes.

However, as is the practice of AXIS MF, they have come out with a unique concept of CONSTANT MATURITY FUND which will replicate the maturity of the 10 year benchmark G sec by buying 9-11 years G Secs (including 10 year benchmark) & create an average maturity of as close to 10 years as possible. In this manner, any G sec trading/investment call can be executed thru this scheme rather than other schemes with varying maturities as explained above.

Now the question is whether timing of this NFO is correct or not & should one invest in the said scheme (when 10 year benchmark has already rallied from 9% levels to currently at 8.22% levels).

WHAT ARE THE POSITIVES GOING FORWARD FOR DEBT MARKETS:

1. There has been some inflows from FIIs; thereby rupee has appreciated currently from a low of Rs.54/$ touched in November/December to currently quoting Rs.51/$
2. Inflation numbers have gone below 8% mark for the first time in some time
3. Due to rising rupee, even imported inflation will come under control; thereby  reduce the inflation numbers going forward
4. Rupee depreciation added fuel to fire in inflation numbers which remained near 10% levels even in September as rupee depreciated between July to August 2011. Hopefully, reverse will be the trend going forward
5. RBI’s change of stance from only controlling inflation to focusing on growth
6. GDP figure will be dismal breaching even 7% or 6.5% number; thereby aiding RBI to start focusing on growth more aggressively
7. All these numbers will push RBI to come out with OMOs, CRR cut, Benchmark Rate cuts going foreword
8. Credit off take numbers way below RBI’s expectations is leaving liquidity in the hands of the banks to chase G secs
9. Inflation numbers will further ease off between January to March 2012 due to base effect & otherwise
10. During rate cut cycles, 10 year benchmark has gone below REPO Rate. This has happened twice in past decade:

• December 2000-November 2001-REPO Rate cut by 150 bps/10 year benchmark yield fell by 307 bps
• July 2008-December 2008-REPO Rate cut by 250 bps/10 year benchmark yield fell by 450 bps. In both instances, 10 year Benchmark Yield fell below REPO Rate

WHAT ARE THE NEGATIVES FOR THE DEBT MARKETS GOING FORWARD: (This will help in creating an average in G Secs investments going forward

1. Generally there is liquidity flow back into the country post December every year. However, March CD rates (quoting 9.50% in December & 10% in January) indicate otherwise
2. There might be disappointment in the market if RBI does not tinker with any rate cuts in January Policy Review; which will give rise to some correction in benchmark yields
3. Also, fiscal numbers in the Budget which will be announced in the month of March will be hugely disappointing
4. Also, auction calendar is yet to get over & is in fact on the higher side due to more borrowing programme announced recently

Assuming that soften by 50-100 bps over next one year, an investor can generate following returns (assuming the Fund Manager captures 8.50% yield during NFO stage by having combination of 9-11 years maturity papers):

TO CONCLUDE:

I recommend investment in the said NFO which is closing on January 19’2012. One should allocate 50% of the allotted amount in the NFO & balance 50% over weekly investment on every Thursday (a day prior to auction every Friday) from now to March 2012. This will help in creating an average once again between 8.20% to maybe 8.40% levels. Disinvestment can happen once RBI starts to act on the rate cut cycle (this will be a separate call which will be given by me at an appropriate time in the future). This should be treated as a trading call once again.

Yield trajectory going forward (with some corrections from now to March) is on the downward side only. Hence, with one year investment horizon & by creating an average as mentioned above, an investor can earn decent double digit figure returns.

DISCLAMIER

I have been recommending some of the debt schemes of Pramerica AMC since their inception. Fund Manager has performed very well even in the most trying periods of debt markets & rising interest rate scenarios. One of the schemes whose strategy is similar to that of Pramerica Treasury Advantage Fund (TAF) was launched in October 31’2011. The said scheme has a dual strategy of capturing high accrual 12 month papers & drawing down on their maturities & buying 15-18 month papers & capturing capital gains due to roll down effect. Besides that, as the name suggests viz. PRAMERICA CREDIT OPPORTUNITIES FUND, they would be having some play on some credit plays.

Most of the times credit opportunities denote that the Fund Manager would invest in lower quality papers and take some credit calls. However, it is not necessarily the case every time. In this case, the Fund Manager is likely to play on those credits which have upgrade possibilities (like one of their investments in Future Capital which was upgraded recently; giving rise to good capital gains) and such similar stories besides only taking credit calls. This helps the portfolio construct in two ways viz. 1) gives higher accrual at the time of investment & 2) gives rise to capital gains in case of upgrades & subsequent compression in yields of these papers.

I would strongly advise investment in the said scheme with such high YTM with one year investment horizon. I would also advise investment in all debt schemes of Pramerica AMC with following investment horizons: