Fixed Income Markets & Strategy of Duration Funds

Fixed Income Markets & Strategy of Duration Funds Market Update: Volatile month for Indian Bonds. Bonds trade with negative bias throughout the month. Bond markets started the month on a cautious note ahead of the scheduled RBI monetary policy meet early month. The RBI policy surprised the markets on both inflation and liquidity management front. While the near-term inflation risks may have reduced, RBI continued to sound hawkish on inflation and even raised the average FY18 forecast by ~25bps. Besides, the lowering of corridor (between Repo & Reverse Repo) by 25bps by RBI also put cap on the overnight rates. Markets have started to price in a pro longed pause, with no rate action in the foreseeable future. However good FII flows in debt market kept the rates market supported, despite the sharp rise in yields, immediately post the hawkish RBI policy. During the mid-month, reversing the sharp sell off seen post the hawkish RBI policy, value buying emerged in Indian debt market on expectations of benign CPI inflation along with slide in US treasury yields amidst global riskoff and stronger domestic currency. The 10yr GSec yield came down to recent lows of 6.77% tracking UST which fell to 2.18% (levels last seen in December) on escalating geo political tensions and weaker than expected economic data. The bond markets further got supported by weaker than expected CPI inflation data coupled with weak IIP growth. However, most of the gains in 10yr GSec were erased after RBI devolved Rs 3216 cr of 6.97% GS 2026 (10yr benchmark GSec) paper on the primary dealers on lack of domestic appetite for the paper. During the later part of the month, bond yields continued its uptrend marginally and the IMD preliminary forecast of a just about normal June-September monsoon, did little to cheer the market on sustainable basis. However, the major uptrend in the yields came in the last week of the month as markets reacted negatively to the unexpectedly ultra-hawkish MPC minutes. The MPC minutes showed that one of the MPC members called for a pre-emptive 25bps rate hike. All members were of the view that inflation will soon inch above RBI s target of 4% as base effect fades away INR continue to gain against USD on buoyant flows in debt and equity markets during the month. Also the appreciation can be explained by a relatively weaker US currency which led to EM currencies gaining against the USD. Global yields continue to edge lower, in particular US yields, as economic data seems to be indicating sluggish economic activity. In addition, before the new administration looks at passing any of its tax proposals, it is facing a shutdown towards the end of the month Market View: In our view, though the RBI policy minutes released sounded cautious on the overall inflation trajectory, there were two strong and contrasting views on inflation. On one hand, Dr Patra sounded extremely hawkish on inflation risks and even called for a preemptive 25 bps rate hike to avoid the need for back-loaded policy action later. On the other hand, Dr Dholakia sounded dovish as he deviated significantly from the RBI s inflation forecast and noted

comfortable inflation dynamics (including core) through FY2018. While we expect ~50 bps of downside to RBI s March 2018 estimate of 5%, headline inflation is likely to remain elevated around 4.6 4.9%. In our view, the macro scenario has been improving and RBI policy reiterates its commitment towards maintaining stable macro environment and hence a conservative stance has been adopted by RBI until a clear picture emerges about international commodity prices, US macroeconomic policies, global growth and inflation scenario and complete impact of demonetisation on domestic economy. Hence though there might be a pro longed pause in RBI s rate action in the upcoming monetary policies, we feel that it's not an end of low interest rate regime (we do not expect any rate hikes in the foreseeable future) and RBI might relook at its present conservative stance once it gets clear indications on above macro parameters and monsoons. Rates will be well anchored because of the Neutral Liquidity stance by the RBI. In line with RBI's current monetary and liquidity stance we reiterate and expect curve to remain steep and accrual strategy to play out well over next couple of quarters. Comfortable liquidity situation, weak credit growth and continuance of stable interest rate scenario would lead to compression of spread between various curves. The combination of better liquidity conditions, revision of Real Interest Rate Target, continued FPI flows in CY 2017, increased demand for G-Secs from banks and more stable overnight rates will support bond markets going ahead. We reiterate that, Steepener and Roll-Down are the best strategy from medium term market perspective and remain the best defensive strategy to generate stable returns over next 6 to 12 months. The present RBI s stance on liquidity coupled with the change in monetary policy stance further supports our Steepener view. 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 and expectations of increased volatility in domestic bond markets, we intend to increase allocation to liquid assets mainly GSecs across our funds. We have benefitted through spread compression as we had increased allocation to high grade spread assets (Corporate bonds, SDLs & UDAY SDLs) instead of government securities in the past two months. We now intend to book profits and switch to GSecs to increase its allocation to liquid assets (GSecs) across our duration schemes. With regards to Dynamic Bond Fund we have already started reducing exposure to 10 year corporate bonds, SDLs & UDAY SDLs (these assets being illiquid in nature). We intend to switch to liquid GSecs exposure and increased allocation to liquid GSecs in the scheme. We intend to further reduce duration of the scheme to around 5 years by allocating 30%-40% to high grade corporate bonds and remaining in liquid 4-12 years Gsecs. Thereby positioning the fund to take advantage of steepening of yield curve. Also because of the highly liquid assets in the fund it will be able to quickly react to any market volatility

Also in the Income Fund, we have already started reducing exposure to 10 year corporate bonds, SDLs & UDAY SDLs (these assets being illiquid in nature) and intend to switch to liquid Gsecs and maintain duration around 5 5.5 years in the medium term and reposition the fund to take advantage of the steepening of yield curve and also benefit from quick portfolio repositioning incase of market volatility. Thus as part of our Core view, we would continue to run 50-60% liquid GSecs (including SDLs), 30 40% high grade Corporate bonds. We have reduced duration during the month as we have reduced the tactical exposure to UDAY SDLs and 10 year corporate bonds and switched to liquid Gsecs of 4 12 year maturity. We intend to run moderate duration of 5.0 5.5 years from short to medium term perspective in both the funds till further clarity emerges on the global growth scenario, global commodity cycle revival path & domestic growth inflation dynamics. Reliance Gilt Securities Fund: In Reliance Gilt Securities Fund, the strategy is similar to other longer duration funds as the fund has increased exposure to liquid Gsecs by reducing the tactical exposure to spreads assets like Normal SDLs and UDAY SDLs and will run moderate duration between 5.5 6.5 years. The fund is currently overweight on 5 10yr maturity GSecs & SDLs and intend to run such positions till the time further clarity emerges on the global growth scenario, global commodity cycle revival path & domestic growth inflation dynamics. Long Duration Funds Portfolio Details as on 30 th Asset Allocation Asset Type Reliance Dynamic Bond Fund Weightage Reliance Income Fund Reliance Gilt Securities Fund Government Bond including SDLs 55.97% 56.36% 93.38% Corporate Bond 33.07% 32.40% - Money Market Instruments and Cash & Other Receivables 10.96% 11.24% 6.62% YTM 1 7.44% 7.51% 7.36% Wt. Avg Maturity 9.69 Yrs 9.47 Yrs 9.99 Yrs Mod Duration 5.90 Yrs 5.78 Yrs 6.26 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 7.56% (RDBF), 7.36% (RIF) and 7.20% (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 54% is invested into bonds with rating profile of AA and better than AA (AAA and AA+), close to 31% in A+/A/A-/A1 rated papers and unrated paper. We expect further credit spread compression due to RBI s endeavour to keep liquidity neutral hence will look to deploy the cash exposure in good credit assets so as to increase the gross yields of the scheme. We are maintaining duration of around 1.87 yrs and current accruals are around 8.86% levels. The YTMs/Portfolio yields have risen recently due to rise in yields across the credit curve. 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 yields of the fund. Curve steepening and rollover benefit have added and are expected to 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 30 th Asset Allocation Asset Type Weightage Corporate Bonds 90.66% Floating Rate Note 1.08% PTC 1.10% Cash, Other Receivables & Money Market Instruments 7.15% YTM Wt. Avg Maturity Mod Duration 8.86% 1 2.33 Yrs 1.87 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 8.56%

Reliance Short Term Fund: We 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. Fund positioning: The current positioning of the fund is ~81% corporate bonds (most maturities between 2yr and 5yr) and around 13% Gsecs (closer to 5yr Gsec & SDLs). GSecs are used as tactical positions and do not form part of our Core positions. Core Positions would be run by maintaining 65 85% allocation in 2 5yr corporate bonds, as yields look attractive both on absolute yield basis as well as roll down perspective. We have recently reduced exposure to 5 year corporate bonds, and switched to 2-3 year AAA corporate bonds and 5 year Gsecs.After the recent spike in Gsecs yields, Gsecs Corporate bond yields have compressed thus increasing exposure to liquid 5 year Gsecs in the scheme. We intend to run such positions till the time further clarity emerges on the global growth scenario, global commodity cycle revival path & domestic growth inflation dynamics. As we expect the yield curve to remain steep, the current fund positioning will help the maximize returns through carry & roll down benefits 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 high grade credit profile as around 85% 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 7.63% with duration of 2.34 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 30 th Asset Allocation Asset Type Weightage Corporate Bonds 80.86% Government Bond including SDLs 13.45% Cash, Other Receivables & Money Market Instruments 5.69% YTM Wt. Avg Maturity Mod Duration 7.63% 1 2.85 Yrs 2.34 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 7.38% Reliance Corporate Bond Fund: The investment philosophy of this fund is 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. 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 endeavour to keep liquidity neutral hence will look to deploy the cash exposure in good credit assets so as to increase the gross yields of the scheme. Reliance Corporate Bond Fund - Debt Portfolio Details as on 30 th Asset Type Asset Allocation Weightage Corporate Bonds 93.96% Cash, Other Receivables & Money Market Instruments 6.04% YTM Wt. Avg Maturity Mod Duration 8.34% 1 3.99 Yrs 2.89 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 8.10%.

Fund Recommendations: Short Term Bond Funds: We recommend investors with preference for high grade investment, funds with duration profile of 2-3 years (Reliance Short Term Fund and Reliance Banking and PSU Debt Fund) in light of lower yields available in comparative products. These are the funds that will benefit from roll down benefit due to the steep yield curve With neutral liquidity framework of RBI, shorter end rates provide attractive carry opportunity at current absolute yields. At least from medium term perspective, we see better opportunity over liquid funds. Relatively high grade credit portfolio and moderate duration would help benefit from both accruals as well as duration. Credit Funds: For investors with credit appetite we recommend investment in our Accrual funds (Reliance Corporate Bond Fund and Reliance Regular Savings Fund - Debt) in light of relatively lower yields available in traditional savings products. In expectations of improving liquidity conditions and money shifting from informal segment to formal banking system will create demand for investment products in line with credit funds especially from accrual perspective. Investors can potentially benefit from a combination of moderate duration along with healthy accruals over next 3 years or more. Common Source: Bloomberg, RBI, RMF Internal Research 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 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

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