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

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:

However, very pro actively managed portfolio & taking right calls at right times by the Fund Manager since their launch has made this product one of the best performing schemes since their launch. What this has done for the investors is that they need not have taken entry/exit calls frequently (as is required in such an asset class) & left it in the hands of the Fund Manager (which should ideally be the case). Though during this phase; debt markets have been most volatile; by sheer pro active management the Fund Manager has managed very decent double digit returns since inception.

Let me reiterate some of the strategies played by the Fund Manager & how actively he managed the portfolio to benefit the investors:

• At the time of the launch, interest rates were on the rise and not peaked off totally. Hence, without taking very aggressive calls or MTM calls, the Fund Manager invested in low 40-45 day duration CDs/CPs by locking in pre March papers at 8.50% to 9% yields
• By end March, when interest rates had reached its peak these papers matured and gave an opportunity to Fund manager to lock in very high yielding 91 day papers going beyond March 2011
• As expected, compression story panned out very well by April end; thereby giving an opportunity to the Fund Manager to book profits on already locked in 91 day papers
• Thus cash generated was reinvested in one month papers whose maturities were falling due between mid May & end May
• As everyone is aware, interest rates once again started inching up between this period; giving an opportunity to the Fund Manager to lock in higher accrual papers
• Also, by this time the yield curve had started becoming steeper (from a very flattish yield curve which was present pre March); giving an opportunity to the Fund Manager to create slightly higher average maturity of 150-160 days by buying 180 day papers at slightly higher yield than 90 day papers & high accrual 90 day papers
• 180 day papers would have roll down effect & post completion of 90 days give rise to capital gains as well (as explained in my note on RELIGARE ACIVE INCOME SCHEME)
• This strategy will work well in a steep yield curve
• Fund Manager has of late started selling 90 day papers (earlier bought at higher yields as 180 day papers; thereby generating capital gains) & converting the same into 1 year CP portfolio as the spreads are still very attractive
• Once the yield curve between 3 month & 1 years starts becoming flatter, the Fund Manger will get ample opportunity of selling CP portfolio at very handsome capital gains
• Hence, slowly & steadily the current 160 day average maturity (10% Gross yield, 30% CD & 70% CP portfolio with 50% in 90 days & 50% in 180 day papers) portfolio will get converted into 360 day average maturity portfolio with higher than 10% yield
• Fund Manager also has the option of buying 2-3 year NCDs (as & when he feels the spreads are good in this segment) & create slightly higher than 1 year average maturity portfolio as well. However, that time is yet to come

As can be seen from above; Pramerica STP has been the most pro actively managed STP with right strategy at right time & generated very good returns even since inception (which according to many market participants was not a good time for launching such a product).

I strongly recommend investment in the said scheme with at least 6 month investment horizon with a possibility of earning lower double digit figure returns. As can be seen from above, even the current strategy of going towards increasing average maturity from 160 days to 360 days is very conservative (without taking undue duration call) at the same time participating in ever changing yield curve to benefit the investors.

Under performance to benchmark over 1/2/3 weeks can be explained to lower duration portfolios v/s some of the other STPs who have aggressively increased average maturities to 1.5 to 2 years. Hence, as can be seen, without taking undue duration calls, the Fund Manager has been able to generate very decent double digit figure returns over all time horizons.