Debt Opportunities

Written by Lakshmi Iyer | Updated: Dec 2 2013, 14:03pm hrs
Indian debt markets witnessed high volatility in the June-Sept-13 period with the shortterm yields hardening up by more than 300 bps. In the same period, the 10-year G-sec rose from 7.16% to touch a high of around 9%.

The genesis of this volatility was in the rising fear of an impending QE3 tapering, which led to a sharp fall in the rupee (a peak to bottom fall of around 18%) against the dollar. It was this tumble in the rupee value which prompted the RBI to tighten the liquidity flow, as also to raise its effective borrowing rate (MSF).

However, the hardening of the yields in the US debt market, and the less than sufficient recovery in the inflation and the US jobs market, have prompted the US Fed to postpone the tapering (into 2014). This has considerably improved the Indian forex and debt market sentiment and also provided time to factor-in the post-tapering effects on various assets. This improvement in the forex and debt market sentiment has allowed the RBI to gradually normalise the policy rates. The operational borrowing rate (MSF) was reduced by around 150 bps in a matter of weeks.

In this period, RBI increased the repo rate in two tranches of 25 bps each to 7.75%. This hike in repo rate was done on account of the rising benchmark inflation (especially due to price rise in food commodities). As a result, the G-sec yield curve has steepened, with the fresh 10- year benchmark finding support at around 8.70% levels. In the money market, most of the T-bills are trading at around 8.80% to 8.90% band.

The debt market appetite seems to be moderate on account of the uncertainty surrounding further repo rate hikes. The discontinuous nature of OMO action by the RBI too does not provide ample comfort to the market. It is apparent that central banker is trying to keep the rupee and the debt market yields in a manageable range, for the time being.

The RBI seems to be waiting for the QE3 tapering schedule to play out, so as to absorb any unforeseen behaviour in the domestic markets. This waiting period may also allow the repo rate hikes and the boosting agri-supply to restrain inflation. Post this play out; RBI may have obtained some room to effect a more growth-oriented policy stance, before the election year budget sets in.

This backdrop provides a range of opportunities and signals for investors. With the feeble GDP growth rate dependent on benign monetary conditions, the repo rate outlook (with a one-year horizon) has a largely downward bias. For now, the 10-year G-sec and commensurate AAA is trading at 8.70% and 9.46%, respectively, with a spread of 76 bps. This outlook provides an argument for investment in a high quality duration fund for such an investor who maintains a one-year-plus investment horizon, and is willing to take some duration risk. Such an investor would be able to capture in on the high yields available, while also position himself/herself for a likely MTM gain in case of a rate reduction.

For such investors, who want partial MTM exposure, and have a six-nine month investment horizon, the short-duration fund emerges as an option. The two-year G-sec and commensurate AAA is trading at 8.54% and 9.77%, respectively, a spread of 122 bps. The investment in such a product at around this duration may provide high carry while also delivers a flavour of MTM gains to the investor.

For such an investors, who are seeking very little (to no) MTM exposure, and have an investment horizon of around one-to-three months, the investment in Ultra Short-term debt funds may be a viable option. With high quality money market CPs trading in the 8.85-9.85% band, the investor can look at capturing high return possibilities for the period, with very little MTM related volatility.

Investors with 1-15 day investment horizon can look at making relatively higher returns (in comparison to other commensurate options) by investing in liquid funds. With the T+1 time duration for transaction, such investors can not only manage his/her regular liquidity (payment/ billing) needs, but also make slightly more money.

Fixed Maturity Plans also present themselves as a viable option for such investors who want a largely stable return with little NAV-related volatility in between. For such investors, mutual funds buy high-yield good quality bonds and holds them till maturity. Most of these bond maturities overlap with the maturity date of the FMP. Since there is little to no trading in between the launch and the maturing date of the mutual fund, the entire MTM gets overridden, and investor gets the whole proceeds.

In closing, a market presents multiple investment opportunities, what is needed is an investor who is self-aware about the investment horizon, and has a reasonable perspective on the risk-reward tradeoff.

The author is senior VP & head (fixed income & products), Kotak Mahindra Asset Management Co