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

Other alternative is parking their funds in Fixed Deposits with some assured returns but a very tax in efficient vehicle (as the investor will have to pay full tax on interest). Also, in FDs, funds get stuck for a period of time like 1/2/3/5 years & hence, the investor loses on liquidity as well. Also, the principal amount at the end of the FD tenor does not appreciate & the investor gets back the same amount which he/she would have invested at the beginning of the period. Also, many times these returns do not even beat the inflation.

In such a scenario, the investor who wishes to earn a regular income is at a tremendous loss in terms of options available to him to earn regular income to meet his day to day expenses. However, one strategy that can help an investor overcome all the above viz:

Is SYSTEMATIC WITHDRWAL PLAN from well managed MONTHLY INCOME PLANs. This tool, besides being an extremely tax efficient way of having regular cash flow for the investor also has a capability of enhancing the overall portfolio value (if managed well & withdrawals of the investor on an ongoing basis is less than the overall returns of the scheme i.e. if the scheme has performed say 12% p.a. in one year & the investor has only done SWP of say 8.50% p.a.; then the investor besides withdrawing regular sums through SWP is also enhancing their overall portfolio value).

Following analysis of two of the best managed MIPs viz. Reliance Monthly Income Plan & ICICI Prudential Monthly Income Plan will show case how SWPs score over traditional FDs in terms of returns & tax efficiencies over a period of time. The way the following table are designed are based on an original investment value of Rs.10 lacs at their respective NAVs & SWP @8.50% p.a. i.e. Rs.7100/- p.m.  :

being an exception as equity markets had collapsed in that year)  from the start & the investor has paid very little tax compared to tax implications on FD interest

ANALYSIS OF RELIANCE MIP SINCE  JAN 2001:

As can be seen from above on Y on Y i.e. from Jan 2001 to Jan 2002 value of your MIP after Rs.85,200/- as SWP is worth Rs.11,42,011 with tax implication of only Rs.1,526 v/s tax implication of Rs. 25,560/-  in FDs . On cumulative basis since Jan 2001 till Jan 2010, an investors has don an SWP of Rs.7,66,800/- having total tax implication of Rs.41,161/- (including Short Term & Long Term & again assuming that the investor is redeeming from MIP at CV of Rs.11,42,011/-) v/s same interest of Rs.7,66,800/- on FD  having an a tax implication of Rs.2,30,040/-.

ANALYSIS OF RELIANCE MIP SINCE JAN 2008: YEAR WHEN EQUITY MARKETS CRASHED:

As can be seen from above on Y on Y i.e. from Jan 2008 to Jan 2009 value of your MIP after Rs.85200/- as SWP is lower at Rs.8,96,969/- with no tax implication (due to loss). However, on cumulative basis from Jan 2008 to Jan 2010, value of your MIP has grown to Rs.9,16,047/- with no tax implication (due to losses). Total value of your investment in MIP plus withdrawal is Rs.10,86,447/- v/s total value of FDs plus interest less tax is marginally higher at Rs.11,19,280/-

ANALYSIS OF ICICI PRU MIP SINCE  JAN 2004:

As can be seen from above on Y on Y i.e. from Jan 2004 to Jan 2005 value of your MIP after Rs.85,200/- as SWP is worth Rs.9,56,706/-  with tax implication of only Rs.450/- v/s tax implication of Rs. 25,560 in FDs . On cumulative basis since Jan 2004 till Jan 2010, an investors has done an SWP of Rs.5,11,200/- having total tax implication of Rs.33,762/- (including Short Term & Long Term & again assuming that the investor is redeeming from MIP at CV of Rs.12,15,317/-) v/s same interest of Rs.5,11,200/- on FD  having a tax implication of Rs.1,53,360/-.

ANALYSIS OF ICICI PRU MIP SINCE JAN 2008: YEAR WHEN EQUITY MARKETS CRASHED:

As can be seen from above on Y on Y i.e. from Jan 2008 to Jan 2009 value of your MIP after Rs.85200/- as SWP is  at Rs.10,01,096/- with no tax implication v/s similar interest on FD of Rs.85,200/- having a tax implication of Rs.25,560/-. However, on cumulative basis from Jan 2008 to Jan 2010, value of your MIP has grown to Rs.11,15,173/- with  tax implication of Rs.12,108/- after SWP of Rs.1,70,400/- v/s same interest of Rs.1,70,400/- on FD having tax implication of Rs.51,120/-

CONCLUSION:

All these combined with a stiff exit load of 2%( if an investor exits within one year of investment will) a) give stability to the portfolio b) due to investments in NBFCs/AA rated papers & PTCs will give higher carry yield & c) with investors also drawing down on the maturity alongwith the portfolio due to exit load for one year will give a certainty of locked in returns less expense ratio.

Other Scheme Attributes: ( as on July 31’2009)

Break up of the Portfolio as on July 31’2009:

Holdings of the Scheme as on July 31’2009:

I would recommend investors to look to invest in the said scheme with one year plus investment horizon. Also, the Fund House is likely to stop accepting funds ( or will stop marketing the said scheme) post August 31’2009 once they reach a critical mass. This will ensure that frequent entries at a later date will not dilute returns of existing investors who would have invested by that date. Hence, besides the high accruals there might be a possibility of capital appreciation ( as & when short end of the curve between 1-2 year segment starts to cool off). One can ( based on current portfolio & likely investments till August 31’2009) expect a return of between 7.50% to 8.00% p.a. (post expenses) over one year horizon.