MY COMMENTS IN AN ARTICLE IN ET MUMBAI

ONCE AGAIN TIME TO RELOOK AT AXIS SHORT TERM FUND

As expected, 3G money outflow has resulted into a deficit in system liquidity (+42000cr surplus for week ended 21st May to -59990cr deficit for week ended 11th June). As a result, short term rates have reacted upwards – overnight MIBOR at 5.35% (3.80% in May), 3m CD at 6.15% and long rates as follows:

AAA Bond	19th Apr (Before RBI Policy)	12th May	14th June
1Y	6.6	6.23	6.75
1.5Y	6.75	6.6	6.9
2 Y	7.2	6.93	7.25
3 Y	7.68	7.3	7.45

While advance tax outflows (approx 30-35k cr) seem to have been priced in current liquidity calculations, BWA auction outflow of approx 39k cr will happen by 21st June and is likely to put further pressure on liquidity. One more negative is just announced WPI inflation of 10.16% for May against expectations of 9.6% with extremely hawkish revisions (11%) for the previous month. Street is still divided over whether this will lead RBI to tighten in a more aggressive manner than spelt out earlier (“baby steps”) when global outlook is still uncertain and central banks there clearly in no hurry to withdraw accommodation.

Even after reacting upwards, current levels have maintained steepness. As RBI is prepared to provide system liquidity at 5.25 (by temporarily cutting SLR), 3m onwards curve starting from 6.25 provides enough cushion. And as system liquidity eases by government spending (approx 10k cr/week) and Gsec maturities (51k cr by 28 Jul), rates will slowly drift towards lower band of corridor – 3.75%. Even if we assume that RBI will hike by 50-100bps by December (50bps as per “baby steps” and 100 bps in aggressive stance), current levels provide good opportunities of roll down (6m-1y spread at 50bps) and capital gains. AXIS STP (ASTF) has maintained the duration of 1.15 years (range: 1-3Y) during the current liquidity tightness. They plan to increase it gradually in coming days to play out the steepness for a period of next 6-9 months.

ASTF characteristics are as follows:
Mod duration:	1.15 years
Gross Yield:	6.50%
Credit quality:	100% AAA

Portfolio Composition as on 14th June:
CDs	74%
Bonds	25%
Cash	1%

As mentioned in my earlier notes, this is the right time to capture short term rates in your portfolio through aggressive allocations to schemes like ASTF with at least 6 month investment horizon from the point of view of roll down effect that it will have as well, higher accruals without undue increase in portfolio duration & compression effect & subsequent capital gains that it will bring in post July once Govt starts spending alongwith G Sec redemptions that will take place in July.

AN INVESTMENT OPPORTUNITY IN KOTAK CREDIT OPPORTUNITY SCHEME

Kotak Credit opportunity fund is aimed to optimize the returns with an optimal mix of duration buckets without diluting the credit quality to the extreme end of the credit curve.

Refer to my note published today on how Short & Long End of the Yield curves are moving in opposite directions; giving excellent opportunities to Fund Managers to capture higher yields at short end without increasing duration unnecessarily. As mentioned in that note, those schemes which will be able to capture higher carry in this tightness (which is going to be temporary) will benefit more than those who are already fully invested.

The product strategy is primarily to encash the extreme steepness of the bond curve where the differential between 1yr and 3yr which was 150 bps but has currently come down to almost 80 bps. Corporate yield curve has therefore started flattening from the steepness it experienced in the recent past. 1 year CP rates have gone as high as 7.25% (Tata Tele raised 1 year CP at this level). 1 yr CD trades are happening at 6.50% to 6.75% but 2.5-3yr levels are still trading at 7.30-7.50 band bringing the spread down to ~80 bps. The tightness is expected to stay till mid June 2010.

In simple language if one holds a two yr paper for more than 1 yr the carry is 100-150 bps higher then 1 yr rate and at the end of one year in case if rates go up more than 100 bps the HPR (Holding Period Return) will be close to YTM and if it doesn’t then the returns will be higher then the YTM because of the roll down.

Now, so far the said scheme has been able to create a portfolio with average maturity of ~2yr and Portfolio YTM of ~7.50% as they have taken 50% of the intended assets and the remaining we are in the process of creating.

Opportunity Ahead:

For the reasons mentioned in my today’s note for liquidity tightening  in the month of June & possibility of systemic liquidity going in negative territory, there is every possibility of banks withdrawing from MFs; putting further pressure on the extreme short end of the curve.

The Fund Manager will look to accumulate ~1yr CP/CD/PTC in the current tightness and will expect to get ~7.50% YTM for the remaining portfolio. Post Mid June when the Liquidity will come back in the system the curve will become steep again which could lead to capital gains in the portfolio.

Secondly Post July 2010 Mark to market guidelines for more then 3 month CP/CD will hit and therefore the curve will become more steep as the liquid and Liquid Plus will reduce duration and there will be less takers for papers between 91-365 days maturities which will bring down the returns in the Liquid plus schemes and therefore products like Kotak Bond Short Term and Kotak Credit Opportunities Scheme will attract flows and the short end rates will either remain stable or come down which will benefit the scheme.

I would strongly recommend investment in the said scheme with one year investment horizon as there is exit load of 1% applicable if one redeems within one year from the date of investment.

LONG END & SHORT END MOVING IN OPPOSITE DIRECTIONS

Short End & Long End of the curve are moving in opposite directions. Reasons are obvious and some of them can be traced to the same economic and commercial activities happening in the markets. Like better than expected ( almost double) collections in 3 G Auction of Rs.68000 crs is one of the reasons for positive movements in the long end of the curve; whereas short term borrowings by the Telecom Companies (Telcos) to bridge their financing requirements by May end are creating ripples in the short end of the curve.

When I last published my note on AXIS Short Term Plan on May 14’2010, rates at the short to medium term were as follows ( as on May 12’2010) :

	May 12’2010	May 21’2010
3 MONTHS	5.00%	5.75%
6 MONTHS	5.30%	6.10%
1 YEAR	6.23%	6.45%
2 YEAR	6.93%	7.02%
3 YEAR	7.30%	7.35-7.40%

As can be seen from above, short end rates between 3 months to 1 year have gone up between 70-75 bps to 20-25 bps already in a very short period of time. This sudden spurt in yields can be attributed to the temporary borrowing being undertaken by most of the Telcos who had successfully bid for 3 G auction & have to shell out funds before May 20’2010. They are allowed to raise cheaper funds through ECB route within 1 year from now. Hence, this temporary bridge financing has shot up the 3 mths CP to 1 year CP & CD rates. Tata Tele raised one year CP at 7.25% & AIRCEL has raised the same tenor CP at 9.75%.

Also, Rs.68000 crs raised under 3 G auction is likely to be going out of the system ( till Govt does not start spending ) & going into the Govt coffers. This is going to create a mismatch of cash flows in the system. This coupled with advance tax outflows might take systemic liquidity into negative. In such a scenario, the banking system also might redeem their MF investments of close to Rs.1 lac crs parked by them in liquid/liquid plus schemes. In such a scenario, we might see the banks accessing the REPO window at 5.25% levels for a short while.

All the above will give ample opportunities to the Fund Managers to invest in 1-3 year papers in much higher yields when short term rates peak off mid June’2010 & creating a slightly higher average maturity profiles of between 1.50 to 2 years. Most of the Fund Managers ( not necessarily all) would have booked their profits in their CP/CD & 2-3 year papers by now & should be sitting on cash to take advantage of these developing situations.

Another factor which will be determined by the demand/supply situation post July 01’2010 (post the new SEBI guidelines kicking in for valuing securities on MTM basis) is the valuation of papers between 91-365 days. If most of the liquid plus schemes shy away from taking slightly higher average maturity/MTM calls in their liquid plus schemes, these papers will have no takers for some time.

Hence, one needs to carefully study impact of all these factors on the shorter end of the curve before investing in short term plans going forward. If at all, one can take a call of exiting aggressive short term plans which have higher average maturities & higher component of MTM papers & stay invested in those schemes which were lower in duration/ invested more in CDs ( with in built profit like AXIS Short Term Plan & Kotak Bond STP, which can be sold at profit) & those schemes which have already booked profits & sitting on cash (like Canara Robeco Short Term Plan which has booked profits on their CP/CD & NCD portfolio & sitting on 50% of the portfolio in cash).

I would recommend investment in this asset class with at least 6 month view starting second week of June’2010.

As against the above, another interesting story is unfolding on the longer end of the curve. I had first given following reasons for looking at the longer end of the curve as early as December 07’2009. I had mentioned following reasons for looking at the longer end of the curve:

“Once Again an Investment Opportunity at the Long End & Why:

• It is that band of the trading zone ( mentioned in my November 03_2009 note) when one can look to invest at the long end for following additional reasons

• As mentioned above, any rate hikes or CRR hike will have an immediate impact at the short end rather than the long end

• Year end buying by Insurance companies will boost long end rates

• Credit offtake still dismal which was evident when SBI cut their lending & deposit rates & the same was followed by other banks as well a few months back

• Next year Fertiliser & Oil subsidy should be on the lower side

• Hopefully no more fiscal stimulus packages need be announced in the next year which can increase the borrowing programme like in the current year

• If at all, fiscal & monetary stimulus packages might be rolled back gradually, giving rise to higher revenue collections & hence lower borrowing

• State Governments have collected a huge amount of approx.Rs.1 lac crores @8.50% in their small savings schemes; hence they also might have lower borrowing requirements next year

• With rise in GDP, revenue collections for the forthcoming years should improve dramatically

• Also, healthy disinvestment of PSU Equity figures which have been planned going forward alongwith collections from 3G Auction should also help in reducing Fiscal Deficit numbers”

As can be seen from above points, most of the reasons why I had thought long end of the curve should do well are panning out quite well one by one. Besides almost double the collections of 3G auction collections & healthier tax collections, there is still untapped potential on the disinvestment side. Also, with European crisis pushing demand for safe heaven government debt like US treasuries as well Indian treasuries, oil at $70/bbl, Indian bond yields have fallen to their lowest levels in last 5 ½ months; currently 7.80% 2020 is quoting at 7.33% against 7.55% on May 12’2010 & 7.80% when it was first auctioned in April’2010.

With better than expected collections of 3 G auction, there are rumors of either a couple of auctions getting cancelled or Govt borrowing programme getting truncated. Since we are in a similar situation like mini 2008 global crisis, RBI might have a rethink on their medium to aggressive rate hike stance to a slower pace of rate hikes. Also, there is a possibility of further hikes in FII limits of buying GILTs. All this will augur well for the long end of the curve. There might be a slight blip in this story in the month of June for reasons mentioned above affecting the short end of the curve as long end also might move in conjunction with short end due to depressed sentiments.

In such a scenario, 10 year benchmark may retrace some of the recent gains & bounce back to say 7.50% levels in June’2010; thereafter it can settle sub 7.25% levels. One can look to invest in long term GILT/Income schemes in mid June’2010 or once it starts retracing some gains from current levels.

AXIS SHORT TERM PLAN : AN INVESTMENT OPPORTUNITY

I have been recommending investments in AXIS STP since their NFO on January 20’2010. Since then, I have recommended this scheme from time to time as the Fund Manager has stuck to his mandate & delivered performance over various time horizons:

Current Parameters of AXIS Short Term Plan ( as on May 11’2010):

Portfolio Composition as on 20th April:

Post RBI Policy Review in April, with lower than expected rate hikes, debt markets rallied for some time as is evident from below yields. However, with Government spending more than their current borrowing ( thereby going negative with their account with RBI by almost Rs.30,000 crs) & hence the funds from 3 G Auction getting transferred to Govt coffers for some more time ( till it starts spending again); markets gave up some early gains & yields started inching up:

Yield Curve still remains very steep; giving ample opportunity for the Fund Manager to:

• Capture higher yields by increasing average maturities marginally
• Roll down effect will help the current portfolio of almost 74% in high yielding March CDs. New MTM guidelines will help boost NAVs of the scheme due to current in built profit in the scheme even if the Fund Manager does not book profits. Post July 01’2010 all the securities beyond 91 days in maturities will have to be marked to market; thereby boosting NAV of such schemes
• Ample cushion available in the current portfolio construction if there is a rate hike between now & July with 74% of the portfolio in high yielding CDs
• Higher yields in 1-3 year papers will help Fund Manger to capture higher yields for fresh inflows
• 3G money transfer effect on liquidity, even if it actually transpires, is likely to be a short-term phenomenon. RBI, in its annual policy, has acknowledged the need for “supportive” liquidity conditions so that Government’s borrowing program is not hampered. Also, credit-off take tends to be relatively lower in first half of financial year.

All the above points augur very well for both existing investors as well as new investors to invest in the said scheme.

Current Steepness in the market:

I would strongly advise investment in the said scheme with at least 6 month investment horizon.