Fixed Income Markets & Strategy of Duration Funds December 2017 Yields at over one year high; Demand-supply concerns and Fiscal risks re-emerge. The month of November started on a bearish note as fiscal worries kept bond market on its toes. Market traded with a negative bias owing to unconfirmed media reports that government was considering slipping on the fiscal target of 3.2% of GDP. Lack of triggers saw yields rise marginally at the start of the month prior to the keenly awaited monthly inflation print. It worsened further as October CPI (Consumer Price Index) inflation came in worse than expected. The 10-yr yield breached the key technical levels of 7% mark. It continued to rise on stop loss triggers by traders and investors and lack of value buy saw yields rise to 7.09% mid month. A surprise sovereign upgrade by Moody s to Baa2 from Baa3 buoyed market mood but it proved temporary in absence of increase in FPI limits. The bond market saw huge swings during the week. The 10-yr yield touched the low of 6.90% but gave up all gains to end the week at 7.06%. The following week market again started on a cheerful mood, with the 10-yr yield swinging back to sub 6.95% levels largely on account of cancellation of upcoming OMO (Open Market Operations) sale and short covering trade. The buoyant mood did not sustain largely as crude continued to tick up, domestic liquidity surplus shrinks and as concerns on fiscal and inflation remain. The benchmark 10-yr yield reverted to 7.05% by month end reflecting lack of sustained buying conviction among investors. Market keenly awaited domestic GDP data as well as OPEC (The Organization of the Petroleum Exporting Countries) meet results for further cues on interest rates. Domestically, the 2Q GVA (Gross Value Added) growth print saw a cyclical recovery and rise to 6.1% as against 5.6% in the previous quarter, partly helped by sequential improvement in corporate earnings, exports and industrial activity. Further the October fiscal deficit data (96% to GDP) did disappoint market. Globally, OPEC meeting did not have any negative surprise and brent crude prices remained anchored at 62 64$/bbl. The month ended with 10yr GSecs yields rising to 7.06% (vs 6.86% last month) amid sharp pick up in US Treasury yields on the back strong data and optimism over the tax reform vote. The month of December started on a bearish note as GSec yields rose sharply on lack of clarity regarding Fiscal Deficit for FY 18 / Extra borrowings, hawkish MPC (Monetary Policy Committee) minutes, continuous rise in crude prices (Oil @ 64.5$ ) & UST (US Treasury) yields (2.50%) Lack on Clarity on GST Revenue collections have raised concerns over meeting this year s Fiscal Deficit target (3.2% of GDP), hence raising fears of extra borrowings in FY 18. Also continuous rise in commodity prices, esp. Crude Oil & Tax Reforms in US have also led to sharp rise in USTs (currently at 2.50%) and strengthening of dollar.
Market View: Reasons for recent spike in Yields: Fiscal Concerns: Concerns around the Bank recapitalization bonds seem to be overblown for now and if kept below the line item, it will have no implications for headline fiscal deficit. Though the further details of the structure are keenly awaited, the fear of it being given SLR (Statutory Liquidity Ratio) status / marketable security status will hurt incremental demand by banks in government bonds and this has kept market participants to being cautious. GST tax collections at the current run rate might be a cause of worry but uncertainty of tax refunds fail to give a clear picture of the tax revenue shortfall. Excise cuts due to sharp rise in crude oil prices will have direct impact on centre as well as states revenue collections OMO Sales: RBI has sold almost INR 90,000 crs of GSecs in the open market to suck out permanent / durable liquidity in the market. On an average INR 30,000 crs of additional monthly supply has hit market through OMO sales broadly in the 3 8 yrs maturity bucket. This has resulted in sharp rise in yields at the shorter end of the GSec yield curve. Though RBI at the start of the OMO sale cycle had allayed market fears of causing disruptions to the normal market borrowing plans, it has now started affecting the demand supply very negatively. Sharp Rise in Crude Oil price: Crude Oil prices surged to highest levels post 2015 amidst political uncertainty in the Middle East Region combined with strong assurances from OPEC and Russia regarding the extension of the production cut. Rise in Crude oil price has both fiscal as well as inflationary impact for India. Higher Inflation: Continuous rise in CPI inflation in last six months. Core CPI inflation at 4.6% levels has risen from below 4% levels. Bond markets are taking out all rate cut expectations and poised for a prolonged pause with an outside chance of a rate hike in FY 2019. Continuous revision of fuel prices on the back of rising crude oil prices has also led rise in inflation expectations though excise cuts have compensated for sharp increase in retails prices.
Our View: Volatility in Crude Oil prices & fiscal concerns will keep bond markets on the edge in the short term. Though a 10$ rise in crude oil prices has limited impact on inflation (25-40bps), it has larger implication as far as Fiscal Deficit in concerned. Excise hikes had resulted in huge revenue collections during last 2 years when oil prices continued to slide. Roll back of excise duties in case of continuous rise in oil prices, will cause massive shortfall in revenue collections especially at the time when the tax system has undergone major reform recently (GST implementation). Though the Fiscal clarity, impact of GST will emerge only post the December quarter, postponement of fiscal consolidation process can be seen as a temporary short term negative as far as FPI investors are concerned. We feel concerns about fiscal slippage are already priced in the current yields. Fiscal uncertainty issue is positively addressed by the finance ministry time and again. We do not expect any major fiscal expansion though there might be some deviation from the fiscal glide path defined in the FRBM Act. The government has already started cutting on expansion and if need be, there is space to accommodate more supply as it has intentionally planned for a light supply in Q4 FY18. If the government sticks to this year s fiscal deficit target of 3.2% GDP, it will be a pleasant surprise for the market and yields can ease sharply. On the OMO supply front, our estimates suggest RBI should be nearing its end of OMO sale and demand supply (ex fiscal slippage) will turn positive in Q4 FY 18. Crude prices can be the only dampener as far as India macro story is concerned and its upward trajectory will be watched very closely. RBI s hurdle for further rate accommodation is very high (as spelt out in the recent MPC minutes) & with inflation trajectory higher than its 4% target & concerns about fiscal deficit, bar for a rate cut is extremely high in the upcoming monetary policies. In the current macro and external environment, we expect a prolonged pause in interest rates With the current RBI s liquidity stance and relatively higher absolute yields, we expect Liquidity trades to dominate Macros trades from medium term perspective. Carry will be the biggest driver for returns in the current interest rate regime. We clearly expect spread assets to outperform going ahead & curve to bull steepen as carry remains attractive at the shorter end of the yield curve. Also roll down benefits will add to the returns on steeper yield curves. We also expect bond yields to remain range bound from near term (3-6 months) perspective as market starts pricing in a prolonged pause on policy rate action. Value buying shall emerge at the current levels of yields as spreads wrt to Repo rate are as high as ~125 150 bps for a 2 3 year AAA corporate bonds & ~ 130 bps for 10yr GSecs. We do not foresee any major swings in yields unless commodity prices rally significantly further or US yields jumps materially.
Fund Strategy: Long Duration Funds: Reliance Dynamic Bond Fund, Reliance Income Fund & Reliance Gilt Securities Fund Reliance Income Fund & Dynamic Bond Fund: In light of our current market view & Bull Steepening view, we have recently further reduced duration across both our duration funds. As part of our Core positioning, we intend to reduce duration and maintain it around 5.00 5.75 years primarily through a mix of liquid GSecs, high grade corporate bonds, shorter maturity GSecs (5 9 year) across our funds. We have been running ~15% cash in both the funds and will tactically deploy the same at opportune time. Post the neutral stance in policy and till the time further clarity emerges on the fiscal front, we intend to maintain lower to moderate duration between 5.00 5.75 years in both the schemes. Thus as per our Core view, we would continue to run 50 60% GSecs & rest into high grade corporate bonds. Reliance Gilt Securities Fund: In Reliance Gilt Securities Fund, the strategy is similar to other longer duration funds as the fund had increased exposure to liquid Gsecs & shorter maturity GSecs (2023 2025 maturity) by reducing the tactical exposure to spreads assets (illiquid Gsecs). We intend to maintain duration between 6.0 6.50 years. The fund is currently overweight on 5yr 10yr maturity GSecs & and intends to run such positions going ahead. Since the last policy was on expected lines with no major surprises and no positive trigger going ahead, we had increased our cash exposure to ~10% in the fund. We intend to tactically deploy cash based on any positive trigger for the market and till then will run the current strategy going ahead. Long Duration Funds Portfolio Details as on 15 th Asset Allocation Asset Type Reliance Dynamic Bond Fund Weightage Reliance Income Fund Reliance Gilt Securities Fund Government Bond including SDLs 50.66% 74.16% 88.33% Corporate Bond 36.18% 12.60% - Money Market Instruments and Cash & Other Receivables 13.16% 13.23% 11.67% YTM 1 7.39% 7.15% 7.12% Avg Maturity 8.43 Yrs 8.95 Yrs 10.02 Yrs Mod Duration 5.46 Yrs 5.81 Yrs 6.07 Yrs 1 The YTM displayed above is for the invested amount of the portfolio (i.e. excluding other receivables) For the entire portfolio YTM, i.e. including other receivables is 7.53% (RDBF), 7.65% (RIF) and 7.02% (RGSF).
Reliance Regular Savings Fund Debt (RRSF-Debt): The investment philosophy of this fund is to generate alpha by investment into credit assets at attractive yields and spreads in the 2-3 years horizon without carrying high duration (not above 2 years) in the fund. The portfolio is well diversified on issuer, rating and maturity parameters so as to manage credit risk and illiquidity risk in the portfolio. The portfolio on a rating basis is broadly allocated into ~62% is invested into bonds with rating profile of AA and better than AA (AAA and AA+), ~25% in A+/A/A-/A1 rated papers and unrated paper. Post the recent sharp rise in yields, the YTM/portfolio yield has increased sharply and is currently above 9.00%. The endeavor of the fund is to maintain attractive carry of the portfolio along with moderate to low duration so as to benefit in the current interest rate scenario. Given the attractive carry and moderate to low duration focus of the fund, a large part of the total potential returns over the horizon period of 1 1.5 years will come from higher gross yield of the fund. We are maintaining duration of around 2.00 yrs and current accruals are around 8.97% levels. Curve steepening and rollover benefit will further add to potential returns into the fund. Because of the low duration, fund volatility is also low. The fund also gives rich carry due to higher short term yields & right mix of credits. Reliance Regular Savings Fund - Debt Portfolio Details as on 15 th Asset Allocation Asset Type Weightage Corporate Bonds 93.84% Floating Rate Note 1.01% Cash, Other Receivables & Money Market Instruments 5.15% YTM Wt. Avg Maturity Mod Duration 8.97% 1 2.57 Yrs 2.00 Yrs 1 The weighted average YTM displayed above is for the invested amount of the portfolio (i.e. excluding other receivables) For the entire portfolio weighted average YTM, i.e. including other receivables is 8.71%
Reliance Short Term Fund: In light of our current market view, we will continue to run the strategy with low to moderate duration and focus on higher accrual income at the same time maintaining high credit profile (~ 85% AAA) of the portfolio. The strategy is based on the view that current absolute levels of corporate bond yields are attractive considering rich carry across the curve. Also with RBI s current liquidity framework, system liquidity will remain very comfortable going forward, and corporate bond yield curve will remain steep. In line with our macro view and market view, we have recently reduced duration by trimming our exposure to 5 yr GSecs and 5 yr corporate bonds. The fund benefitted recently as GSecs proportion in the fund was less than 5% and SDLs ~13% which has given protection post the recent rise in yields. With expectations of Liquidity plays dominating Macro plays in the short to medium term, we will tactically look to add GSecs exposure and 2 3 yr corporate bond exposure in the scheme. As we expect the yield curve to remain steep over medium term perspective, our Core portfolio positioning will help to optimize returns through carry & roll down benefits over medium to long term. We intend to run Core Positions by maintaining 65 85% allocation in 2 5yr corporate bonds, as yields looks attractive both on absolute basis as well as on a roll down perspective. Credit quality: The fund has relatively good credit profile as around 86% of the allocation is towards AAA rated assets while rest is allocated into AA+/AA/AA-. Low Volatility & High Accrual strategy: The current gross yield of the portfolio is hovering around 7.68% with duration of 2.24 yrs making a case for low volatility, high accrual strategy and would benefit going ahead during downward correction in the yields. The fund primarily focuses on accrual income and potential capital gains. Thus fund runs good credit profile with majority of allocation into AAA credits. Also moderate duration strategy provides protection from volatility and adds benefit due to roll down and higher absolute yields make this product attractive from a 12 to 15 months investment horizon. Reliance Short Term Fund Portfolio Details as on 15 th Asset Allocation Asset Type Weightage Corporate Bonds 78.97% Government Bond including SDLs 15.50% Cash, Other Receivables & Money Market Instruments 5.53% YTM Wt. Avg Maturity Mod Duration 7.68% 1 2.72 Yrs 2.24 Yrs 1 The weighted average YTM displayed above is for the invested amount of the portfolio (i.e. excluding other receivables) For the entire portfolio weighted average YTM, i.e. including other receivables is 7.34%
Reliance Corporate Bond Fund: The investment philosophy of this fund aims to generate alpha by investment into credit assets at various points in time without compromising on quality of the portfolio. An active investment strategy where gross yields are maintained higher than short term bond fund category while duration is almost at par with the short term bond fund category. This provides a perfect blend of Accruals as well as Duration. Post the recent sharp rise in yields, the YTM/portfolio yield has increased sharply and is currently above 8.50%. The endeavor of the fund is to maintain attractive carry of the portfolio along with moderate duration so as to benefit in the current interest rate scenario. Given the attractive carry and moderate duration focus of the fund, a large part of the total potential returns over the horizon period of 1 1.5 years will come from higher gross yield of the fund. The fund currently aims to invest in papers rated AA- and above. The fund would run moderate duration of around 2-3.5 years. In the current scenario investment would be typically concentrated in assets with individual duration range of 3-6 yrs. We expect further credit spread compression due to RBI s endeavor to keep liquidity neutral hence will look to deploy the cash exposure in good credit assets so as to increase the gross yield of the scheme. Reliance Corporate Bond Fund Portfolio Details as on 15 th Asset Type Asset Allocation Weightage Corporate Bonds 93.76% Cash, Other Receivables & Money Market Instruments 6.24% YTM Wt. Avg Maturity Mod Duration 8.50% 1 4.04 Yrs 2.78 Yrs 1 The weighted average YTM displayed above is for the invested amount of the portfolio ( i.e. excluding other receivables) For the entire portfolio weighted average YTM, i.e. including other receivables is 8.27%.
Fund Recommendations: With expectations of Liquidity trades to dominate Macro trades in the short term, we expect curve to bull steepen and carry to be the biggest driver of returns. Thus, Ultra Short Term Funds & Short Term Bond Funds (Reliance Short Term Fund & Reliance Banking and PSU Debt Fund) are positioned to gain from our above view. At the current high absolute levels at the shorter end of the yield curve (2-3 yrs corporate bonds trading ~125-150 bps above Repo rate), a large part of the total potential returns will come from higher accruals in these funds. Across our long duration funds (Reliance Dynamic Bond Fund, Reliance Income Fund & Reliance Gilt Securities Fund) we will continue with the current strategy of Carry (6 9 year Gsecs, 10yr high grade Corporate bonds) and liquid Gsecs (primarily belly of the curve). With expectation of prolonged pause in interest rates, tactical duration plays will be captured through these long duration funds. In Reliance Dynamic Bond Fund, we have modified our strategy by reducing duration from 6.5 7.0 years to 5.0 5.50 years by shifting out from longer maturity & illiquid Gsecs to private AAA corporate bonds & will consider giving allocation to SDLs at appropriate spreads going ahead, thereby targeting an optimal mix of accruals and medium duration. We recommend Accrual funds (Reliance Regular Savings Fund- Debt & Reliance Corporate Bond Fund) over 3 years investment horizon. These funds have potential to benefit from high carry, credit spread compression due to balance sheet improvements & credit migration and roll down benefits on steeper yield curve. Source: Bloomberg, MFI Explorer, RBI, Finance Ministry of India PRODUCT LABEL- Reliance Dynamic Bond Fund Income over long term Investment in debt and money market instruments PRODUCT LABEL- Reliance Gilt Securities Fund Income over long term Investment in Government Securities
PRODUCT LABEL Reliance Income Fund Income over long term Investment in debt and money market instruments PRODUCT LABEL Reliance Regular Savings Fund Debt Option Income over medium term Investment predominantly in debt instruments having maturity of more than 1 year and money market instruments PRODUCT LABEL Reliance Short Term Fund Income over short term Investments in debt and money market instruments with the scheme would have maximum weighted average duration between 0.75-2.75 years PRODUCT LABEL Reliance Banking & PSU Debt Fund Income over short to medium term Investments in debt and money market instruments of various maturities, consisting predominantly of securities issued by Banks, Public Sector undertakings & Public Financial Institutions
PRODUCT LABEL- Reliance Corporate Bond Fund Income over medium term Investment predominantly in corporate bonds of various maturities and across ratings that would include all debt securities issued by entities such as Banks, Public Sector undertakings, Municipal Corporations, bodies corporate, companies, etc Disclaimer: RNAM is not guaranteeing/offering/communicating any indicative yields or guaranteed returns on investments made in the scheme. The information herein below is meant only for general reading purposes and the views being expressed only constitute opinions and therefore cannot be considered as guidelines, recommendations or as a professional guide for the readers. Certain factual and statistical information (historical as well as projected) pertaining to Industry and markets have been obtained from independent third-party sources, which are deemed to be reliable. It may be noted that since RNAM has not independently verified the accuracy or authenticity of such information or data, or for that matter the reasonableness of the assumptions upon which such data and information has been processed or arrived at; RNAM does not in any manner assures the accuracy or authenticity of such data and information. Some of the statements & assertions contained in these materials may reflect RNAM s views or opinions, which in turn may have been formed on the basis of such data or information. The Sponsor, the Investment Manager, the Trustee or any of their respective directors, employees, affiliates or representatives do not assume any responsibility for, or warrant the accuracy, completeness, adequacy and reliability of such data or information. Whilst no action has been solicited based upon the information provided herein, due care has been taken to ensure that the facts are accurate and opinions given are fair and reasonable, to the extent possible. This information is not intended to be an offer or solicitation for the purchase or sale of any financial product or instrument. Recipients of this information should rely on information/data arising out of their own investigations. Before making any investments, the readers are advised to seek independent professional advice, verify the contents in order to arrive at an informed investment decision. None of the Sponsor, the Investment Manager, the Trustee, their respective directors, employees, affiliates or representatives shall be liable in any way for any direct, indirect, special, incidental, consequential, punitive or exemplary damages, including on account of lost profits arising from the information contained in this material. The Sponsor, the Investment Manager, the Trustee, any of their respective directors, employees including the fund managers, affiliates, representatives including persons involved in the preparation or issuance of this material may from time to time, have long or short positions in, and buy or sell the securities thereof, of company(ies) / specific economic sectors mentioned herein, subject to compliance with the applicable laws and policies. Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.