A similar story unfolded in an asset class called Monthly Income Plans (MIPs). When markets corrected from a high of 20827 SENSEX levels reached sometime on January 07’2008 to a low of 8325 reached on March 2’2009; then bounced back from these levels back to around 21,004 levels on November 01’2010, this asset class performed extremely well during this bounce back period. Based purely on returns figure in that year, most advisors started recommending this asset class sometime in November-December 2010 after seeing handsome returns in this asset class. This is evident from the industry corpus growth in MIPs.

Also, as one can logically conclude, MIP as an asset class would have taken a beating during the equity meltdown phase from January 2008 to March 2009; would have performed very well from March 2009 to November 2010 & the once again corrected from then to now.

However, I have been recommending investment in equities thru strategy of Systematic Transfer Plan from Liquid to Equity. If one would have done this even from the peak of January 2008 & continued the same thru the volatile period of March 2009, then once again peaking in November 2010 & once again thru the downturn, returns in the said strategy v/s one time investment in either equity or MIP from January 2008 till May 31’2011 would have looked as follows:

Hence, as can be seen from above, certain asset classes become flavour of the season or a year or so & go out of flavour without giving adequate warning to the investors. As against that, strategies like SIPs or STPs can be an ongoing strategy which can act as flavours for all seasons & can bring a) discipline in investing b) create an average during volatile times of the market & c) try & achieve decent returns for all times to come without investor trying to outguess the markets.

With current equity market conditions, I strongly recommend investors to try and invest thru this strategy of STP instead of trying to time the markets. Additional return in this strategy is also partly attributable to the fact that your principal amount gets invested in Liquid Schemes (currently generating 8-9% p.a.) & slowly & steadily gets replaced with equity assets over a period of time

As expected maximum compression has happened 90-180 day papers (theme which was adopted by J P Morgan Short Term Plan & Pramerica Short Term Income Scheme) & a decent compression with high accruals in 1 year papers (theme adopted by Templeton India Short Term Income Plan & BNP Paribas Bond Fund).

Going forward we expect the same story of high accrual coupled with some more compression (as & when liquidity starts to flow back in the system) happening; thereby giving very decent returns over the next 3-9 month investment horizon.

Current Scheme attributes of these schemes:

J P Morgan Short Term Income Plan:

Gross Yield:                                           10.50%

Average Maturity                               185 days

Exit Load                                                0.15% if exit made within 15 days from date of allotment

BNP Paribas Bond Fund:

Gross Yield                                            10.05%

Average Maturity                               1.05 years

Exit Load                                                2% if exit made within one year from date of allotment

Templeton India Short Term Income Plan: (as on 28^th February 2011)

Gross yield                                            10.61%

Average Maturity                               1.30 Years

Exit Load                                                0.50% if exit made within nine months from date of allotment

Pramerica Short Term Income Scheme:

Gross yield                                            10%

Average Maturity                               135 days

Exit Load                                                0.25% if exit made within 3 months from date of allotment

Returns as on April 04’2011:

I continue to recommend the above schemes with time horizon exceeding their respective exit load limits.

For the following reasons & for the fact that today’s IIP numbers of 5.60% were grossly below market expectations of 9% ; factors which will be favourable for taking some interest rate and duration calls are as follows:

1. We believe G Sec yields have peaked out. Though currently breached 8% & is hovering at 8.03% levels, one will not be able to predict whether this is the high or will it touch 8.25% before cooling off
2. Historically, benchmark yields higher than 8% mark have not sustained for a long period. Last time when we saw this crossing 8%, RBI had devolved its auction bringing the yields lower in the end August
3. Inflation is likely to come down to 7% by December and to 6% by March 2011
4. RBI is nearly done with neutralization of rates. One can expect one more rate hike of 25 bps
5. Positive news on fiscal as disinvestment goes through aggressively
6. Lower bond supply from November, 2010 with Government borrowing less to the tune of Rs.10,000 Crs
7. Strong demand from Banks for SLR as they look to build their deposit base
8. The FII limit for Government Bonds has been increased by US$5 billion with residual maturity of over 5 Years. It has also further increased the corporate limit for infrastructure bonds with residual maturity of over 5 Years

At the shorter end of the curve:

After steep rises of 250 bps, markets appear to have stabilized and forwards are discounting more tightening from the RBI than what is likely to be delivered, there has been no difference between pre and post policy levels. On the contrary, because of quarter end factor, December papers which are now technically below 3 months have rallied 10-15 bps.

We also think money markets rates could continue to face pressure for next 2-3 months on account of liquidity conditions (which will start improving over the next couple of months).

Hence in the current market scenario what are the asset classes that are likely to do well which are the specific schemes that one can look at for various time buckets:

0-30 Days: Pramerica Ultra Short Term Bond Fund: Returns Expectation: 6.80-7.00% p.a.

Their NFO closed on September 23’2010 & has reopened for subscription on September 27’2010. One week returns as on October 06 ‘2010 was 7.29% p.a. as against the industry average varying between 6.25% to 6.75% p.a.

The scheme managed to capture the following:

As can be seen from above, without taking any MTM calls and with an average maturity of 65 days (much less than the general industry average maturity in the ultra short term bond category of 95-100 days); the scheme has been able to capture very high gross yield of 7%. These high rates at the shorter end are likely to continue with negative systemic liquidity. This will give ample opportunity to the Fund Manager to further enhance their gross yield by investing any incremental cash inflows into the scheme as well as by deploying cash component post the NFO.

This scheme can continue to outperform other Ultra Short Term Bond schemes till such time the interest rates remain on the higher side at the shorter end. They continue to delver daily annualised returns between 6.95 to 7.00% p.a.

For 90-180 days: J  P Morgan Short Term Plan:Returns Expectations: 7.00-7.25% p.a.

They have locked into high yields at the short end and now have nearly 80% of CD portfolio locked in 3-4 months CDs at yields of around 7.50%. The balance 20% essentially looks to invest in Gsec (15% – 5 year, 3-5%-10-12 year paper) at the current yields.

150-180 Days: Systematic Weekly Investment in ICICI Prudential GILT Scheme & Birla Sunlife GILT Schemes: Returns Expectation: Double Digit:

For various reasons mentioned in the first para & for the following more reasons I believe there is a short term trading opportunity in GILT Schemes. GILT/Income Schemes have not yielded good results over longer periods of holding. However, there have been times like now and like November 2008 to January 2009 wherein GILT schemes in spurts have outperformed any other asset class. I have been recommending weekly investment in GILT schemes on every Friday since July end Policy Review. The said strategy has paid off very well as can be seen from following table. Since we still expect some more action from RBI, the said strategy should be continued for a couple of more months, create an average of 8% or above & wait for one technical correction in benchmark which can drag the yields between 7.50-7.75% levels. One should then exit from this asset class altogether as new borrowing calendar in February will determine the course of the interest scenario for next Financial Year.

• The difference between the Repo and 10 Year is quite high and my view is that the next 50 bps of rate hike has already been factored in the 10 year yield
• The increasing yields on the govt. bonds and lower supply of long term corporate bonds has resulted in narrowing the corporate bond spreads. The current spread of 10 Year AAA Corporate bond over 10 Year Govt. bond is lower at 75 bps against the average of 106. I believe that the spreads will widen gradually resulting in outperformance of G Secs over corporate bonds of similar maturities
• The spread between the Indian treasury yield and the US treasury yield is at multi-year high even surpassing the highs seen in October 2008. The yield differential between US and India is at historic high, should decline
• Inflation has remained high. Food inflation has been growing in double digits for past many months. A good monsoon will likely result in record food grain production and partly because of base effect, I expect the inflation to coming down

Following chart shows how SIP of Rs.1 cr over past 12 weeks since July 27’2010 till October 12’2010 (an average holding period of 42 days) has done as on October 12’2010:

180-365 Days: Kotak Bond Short Term: Returns Expectations: 7.00-8.00% p.a.

The Yield on the portfolio has touched 8% with an avg. mat of 1.40 yrs though the average maturity appears bit higher the fund manager is working to reduce the same.

The short end of the yield curve was the worst impacted and the long end broadly remained flat and the liquid to illiquid spread also got compressed therefore funds with higher average maturity and relatively illiquid portfolio have out performed in the short run but going forward the short end is expected to do well from a risk reward basis.

Therefore investors who would hold on to their positions for next 3 months are likely to get similar spread over liquid plus going forward and the spreads likely to increase provided the rates do not move up.

365 days plus : Templeton India Short Term Income Plan: Returns Expectation 0.25 +/- the Captured YTM of the fully invested Scheme(Current Portfolio YTM 8.40%) :

I have been recommending investment in Templeton India Short Term Income Scheme from time to time. I have always believed and mentioned in these notes that this scheme is a PRODUCT FOR ALL SEASONS  where the investor does not have to either time the entry or exit or take any interest rate or duration calls on their own.

The Fund Manager has been able to generate returns close to the captured YTM over one year horizon on a very consistent basis. This is being done by a very active management of the scheme, taking calls on corporate bonds keeping in mind :

a) Higher YTMs

b) Spread Compression Stories

c) Upgradation possibilities

d) Roll down effect

e) Capital Gains

365 days Plus: Fortis Bond Fund: Returns Expectations: 8-10% p.a.

Strategy of the scheme will make it an all seasons product. The fund Manager will take some high yielding credit calls, counter with some money market calls for liquidity with strict discipline of not creating an average maturity of more than 1- 1.50 years and no single paper to have residual maturity of more than 5 years. This will ensure lower volatility in the portfolio.

Current scheme attributes:

Ideal portfolio break up:

1/3^rd in Money Market instruments

1/3^rd in PTCs

1/3^rd in High yielding AA-/A+ or higher credit rated corporate papers

If one invests with one year view, one can expect returns between 7.50-9.00% p.a. Roll down effect & capital gains impact can improve returns further.  Since they have monthly/quarterly dividend pay outs; it can be an ideal investment for those looking to have regular cash flows from their investments. Another important strategy of the Fund manager to protect the interests of the investor is to restrict further flows into the scheme once the scheme reaches a critical mass & once when interest rates start sliding down.

Their NFO closed on September 23’2010 & has reopened for subscription on September 27’2010. Since then the returns on the said scheme is 6.48% p.a. Industry average in ultra short term bond fund as on September 27’2010 for 7 days was 5.98% p.a. for institutional category & 5.79% p.a. for regular category.

The scheme managed to capture the following:

As can be seen from above, without taking any MTM calls and with an average maturity of 65 days (much less than the general industry average maturity in the ultra short term bond category of 95-100 days); the scheme has been able to capture very high gross yield of 6.75%. These high rates at the shorter end are likely to continue with negative systemic liquidity. This will give ample opportunity to the Fund Manager to further enhance their gross yield by investing any incremental cash inflows into the scheme as well as by deploying cash component post the NFO.

I would recommend all investors to take advantage of this situation as smaller corpus just concluded NFO scheme will outperform larger corpus existing schemes for quite some time till the scheme corpus grows & shorter end of the curve yields start easing off.

Pramerica is in a unique situation due to it’s sheer timing of the NFO that lower corpus of the scheme is working in its favour without sacrificing on liquidity & without increasing MTM components & at the same time giving investors returns much higher than the existing liquid plus schemes.

Most of the times, Mutual Fund industry has come up with NFOs of  both Equities & Debt when either equity markets are on a run (say SENSEX at 20-21000 levels) or pushed debt market schemes when interest rates have been at rock bottom (say 10 year benchmark at say 5%). Typically markets take note of any asset class only after it has generated enough returns & that actually might be the time to exit those asset classes.

In my long career of 25 years, very rarely have I seen a debt market NFO/ or a sales push when interest rates are at their peak or when equity markets were down in the dumps at say  8000 Sensex in 2008.

Hence, it is a pleasant surprise when Pramerica Mutual Fund is coming out with their Ultra Bond Short Term Scheme when interest rates are at their peak (immediately after the last Policy review on September 16’2010 when RBI once again raised the benchmark rates).

Though this asset class does not have much volatility or much impact of interest rate hikes or reduction (as their duration post August 01’2010 SEBI guildelines of MTM) are on much lower side; one positive in favour of a new NFO is that it will capture very high accruals at the shorter end without taking any MTM calls or going beyond even 90 days in average maturity for their scheme. This scheme due to it’s sheer timing & starting with a clean slate during NFO is capable of outperforming other existing schemes by almost 25-30 bps.

Current Likely Attributes of the scheme: The Fund Manager hopes to create the following portfolio during the NFO Stage:

There have been hardly any redemptions in this month as compared to redemptions seen in September 2009 post the advance tax outflows. Hence, inspite of rate hikes on September 16 policy review, shorter end of the curve has marginally rallied (as against expectations of spike in short term rates). Market participants are expecting the tightness in the liquidity to continue for some more time & are expecting short term rates to go up in first week of October. This will enable the Fund Manager to take a slightly longer duration call of investing even in 100 day CDs (which is yielding almost 30-40 bps higher than the 90 day CDs as the maturity of the said CDs is going beyond December 2010). Hence by even creating an average maturity profile of 90-95 days post the NFO &  without taking too much of MTM calls, the said scheme is capable of outperforming other existing ultra bond short term schemes by as much as 25 bps.

I would personally recommend investing in the said scheme both at the NFO stage as well post NFO stage.