Investors in income funds today are looking for direction
Investors today have a common question when it comes to income funds. “What should I do with my investment
in income funds? I have invested in duration funds and income funds this year when the 10 year G-Sec yield
was around 8.00% p.a. Interest rates have gone up substantially post liquidity tightening measures taken
by the RBI in July 2013. Market volatility has increased since then and given the recent hike in the repo
rate, there is some confusion about what I should do with my investment.” Should such investors hold on, or
switch into short term funds? Let us look at the current investment landscape and endeavour to arrive at an
investment perspective.
The current investment landscape
• We are going to enter a busy season in the second half of the financial year (H2) where the demand for
liquidity will rise due to the festival season and higher consumer spending that is likely to occur after the
harvest season. Therefore, systemic liquidity will remain tight and the RBI will have to inject liquidity in
order to ease systemic liquidity.
• The H2 borrowing program is likely to encounter weaker investor interest due to volatility seen in previous
months.
• Corporate bond issuance is dwindling due to unfavorable yield levels and lack of investor interest. This is
driving borrowers to the banking system for loans, which is visible through higher credit off-take (around
17% YoY despite weak economic growth).
Expectations for the near-term
• We believe that the RBI is going to focus more on controlling inflation and hence may hike the Repo Rate to around 8% by December 2013 (until the core Consumer Price index (CPI) is contained at around 6-7% YoY).
• We expect banks to lend more to the corporate sector and likely reduce their govt. bond purchases.
• We also expect banks to keep issuing more 1Y bank CD in order to bridge their asset-liability gap until
deposit growth picks up meaningfully.
• Based on these factors, we believe that bond yields are likely to remain range-bound with the 10Y govt bond yield trading between 8.5% to 9% in the near-term.
• 12M CD yields will likely trade between 9% to 10% p.a. and credit spreads could widen gradually in order to reflect the underlying credit supply-demand dynamic.
What should investors do?
• We believe that it will be prudent to gradually shift from high duration funds to low duration funds (around
1Y or less) and prefer quality and liquidity over higher yield.
• It is important to note that investors are not compromising on yields for investing in low duration funds
given the flat term-structure of interest rates that is prevailing as of now.
• We believe this strategy will be ideal for superior risk-adjusted returns over the next one year.
Investors today have a common question when it comes to income funds. “What should I do with my investment
in income funds? I have invested in duration funds and income funds this year when the 10 year G-Sec yield
was around 8.00% p.a. Interest rates have gone up substantially post liquidity tightening measures taken
by the RBI in July 2013. Market volatility has increased since then and given the recent hike in the repo
rate, there is some confusion about what I should do with my investment.” Should such investors hold on, or
switch into short term funds? Let us look at the current investment landscape and endeavour to arrive at an
investment perspective.
The current investment landscape
• We are going to enter a busy season in the second half of the financial year (H2) where the demand for
liquidity will rise due to the festival season and higher consumer spending that is likely to occur after the
harvest season. Therefore, systemic liquidity will remain tight and the RBI will have to inject liquidity in
order to ease systemic liquidity.
• The H2 borrowing program is likely to encounter weaker investor interest due to volatility seen in previous
months.
• Corporate bond issuance is dwindling due to unfavorable yield levels and lack of investor interest. This is
driving borrowers to the banking system for loans, which is visible through higher credit off-take (around
17% YoY despite weak economic growth).
Expectations for the near-term
• We believe that the RBI is going to focus more on controlling inflation and hence may hike the Repo Rate to around 8% by December 2013 (until the core Consumer Price index (CPI) is contained at around 6-7% YoY).
• We expect banks to lend more to the corporate sector and likely reduce their govt. bond purchases.
• We also expect banks to keep issuing more 1Y bank CD in order to bridge their asset-liability gap until
deposit growth picks up meaningfully.
• Based on these factors, we believe that bond yields are likely to remain range-bound with the 10Y govt bond yield trading between 8.5% to 9% in the near-term.
• 12M CD yields will likely trade between 9% to 10% p.a. and credit spreads could widen gradually in order to reflect the underlying credit supply-demand dynamic.
What should investors do?
• We believe that it will be prudent to gradually shift from high duration funds to low duration funds (around
1Y or less) and prefer quality and liquidity over higher yield.
• It is important to note that investors are not compromising on yields for investing in low duration funds
given the flat term-structure of interest rates that is prevailing as of now.
• We believe this strategy will be ideal for superior risk-adjusted returns over the next one year.
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