Life Insurance – A Distant Dream for Indians

India, a home to 1.15 billion people and the world’s second largest population stands abysmally low in terms of social security and human needs measures. Since independence, the Government of India introduced many measures to improve the economic conditions of this country. This included various social security schemes, the prominent being ESIC and EPFO followed by some recent measures such as MGNREGA (Mahatma Gandhi National Rural Employment Guarantee Act), National Rural Health Mission etc. The history of Insurance in India dates back to British colonial period, early 19th century. Since then, a lot of reforms came in existence, particularly for Life Insurance. Despite all measures, the penetration of Insurance is still ranked the lowest amongst other countries.

India is an under-insured country and the insurance penetration level stands abysmally low at 2 per cent of the population, the general insurance penetration stands at 0.6 per cent only. With a vast population of 1.15 billion, there is an immense opportunity that needs to be tapped. An estimated 80 per cent of the Indian population is without Life, Non-Life and Health insurance. However, the Indian Insurance industry is poised to grow robustly with a clear path set along the growth trajectory. In terms of total business, the Indian Life Insurance industry has grown from US $ 8.87 billion in Fiscal Year 2005-06 to US $ 41 billion as on Jan 2010, thus, giving an absolute increase of 362 per cent. In an average, the industry has been growing at a rapid pace of 30 – 34 per cent annually, as per Life Insurance Council. LIC, being the earliest player and set up under the Life Insurance Act in 1956 has played a dominant role in spreading its wings across all nooks and corner of India. However, the entry of private insurance players changed the dynamics of Indian Insurance industry.

As regard to the FDI being capped to 26 per cent in Life Insurance, it created an additional opportunity for foreign players who have been looking to tap the untapped insurance potential in India. The total FDI being routed to India under FDI to Insurance is US $ 525.6 billion. The government is keen to reintroduce the Insurance Bill which proposes to increase the FDI level to 49 per cent from the current level of 26 per cent.

But the question arises, why India is still tagged as Under Insurance industry? Have the government not done enough to increase the penetration level to all corners of India?
Why Insurance is sold in India?

Insurance policies are sold in India unlike its developed counterparts where it is sought after. No doubt, the major reason is poverty and low level of penetration in rural areas. The major population which is largely based in rural areas has low level of financial knowledge. Since, majority of India’s population is living below the poverty level (BPL), they are more interested in living their livelihoods instead of protecting their futures against any mishaps. Moreover, the Government of India does not run any social security schemes on its own unlike in other developed countries which contribute on their behalf. The lack of a proper path hampers the penetration level in insurance. One of the tools to measure the insurance development is per capital spending on insurance i.e. insurance density. Based on this measure, India ranks among the lowest spending nations in Asia in respect of purchasing insurance. Another factor that has been slowing the improvement of insurance density in India is its relatively high population growth rate.

The low income level (average per capital income being at Rs. 44,345 in 2009-10) also deters individuals to ask for insurance as a product to safeguard their futures. Moreover, insurance is not compulsory in India except Motor Third Party Liability. There is no other compulsory insurance in India. In a nut shell, the awareness is poor because insurance was not sold for years – it was bought. However, the mushrooming of private insurers has helped in a big way to push insurance products. Apart from the usual agent-client relationships, these insurers have been using new innovative measures such as Direct Marketing, Digital Marketing etc. Since Mobile has reached deeply in every nook and corner of India, insurers have been using it in a big way to push products.
What the government has done to boost Insurance in India?

• FDI up to 26 per cent permitted under the automatic route subject to obtaining a license from the Insurance Regulatory Development Authority (IRDA)

• Private insurance players have been allowed into the Insurance business; earlier it was dominated by LIC

• Set up of Insurance Regulatory Development Authority (IRDA) to regulate the insurance industry

• Set up of Foreign Players in conjugation with the domestic players

• Defining new rural business commitments in terms of number of life insurance policies sold and total premium collected, thus, asking allowing life insurance companies to set up their shops in rural and untapped areas
Entry of Private Players in Insurance Business

After the Government of India (GoI) liberalized the insurance sector in March 2000 with the passage of the Insurance and Regulatory Development Authority (IRDA) bill, it allowed the setting up of private and foreign insurance players in 2000. As a result, the total number of Life Insurers increased to 23 as of April 2010, as per IRDA report. The private players in partnership with foreign players brought new dimensions in the industry along with technological know-how, thus, reducing the operational costs and bringing new efficiency in the industry. The scaling up of private insurers reduced the market share of LIC India which forced them to overhaul their set up and its way of functioning. Entry of private insurance players brought alternative distribution channels to suit customers’ needs. So, the industry has moved from the typical meeting between the customer and insurance agent as seen earlier to new technology. New companies are emphasizing on speed, convenience and ease of transactions. Though there have been some mis-selling being reported, it is the regulatory loopholes which they have been exploiting and in the time to come, it will disappear gradually. IRDA has announced a series of regulations to regulate the insurance industry and also improved the solvency ratio, a measure to test the robustness and strength of Insurance Company. The insurance sector is set to witness a sea change in the way the businesses were traditionally done, with new innovative products, distribution network etc. Insurance players have also been experimenting direct marketing plans and have been successful too, to some extent.
Scope of Private Insurers in future

The future looks promising for Indian insurance industry. The private players have reached to untapped area. In some products like annuity or pension products business, the private insurers have covered a significant portion of the total market share. The most popular product Unit Linked Insurance Product (ULIP), locked in the spat of two regulators i.e. IRDA and SEBI have gained significantly, thus, creating a virtual monopoly in terms of over 90 per cent of the new customers. The government also moved and set up Micro Insurance Act to allow insurance companies to roll out Micro Insurance products suited for low income level population. With increased consumption power and overspending in rural areas, these rural folks are going to be the major customers for the economy. Moreover, the government is committed to improve its economic figures and it is bound to happen if it improves the social security conditions in rural areas in terms of Micro Insurance policies.

The Road Ahead

The saturation of insurance markets in various developed economies has made India an attractive market for foreign players. As per a report “Booming Insurance Market in India (2008-2011)”, the life insurance premium in India is projected to grow US $ 266 billion by 2010-11. The main objective is to make the participants familiar with the role of insurance in economic development.

Liquidity tightened on 3G outflows; RBI introduced ad-hoc liquidity measures

Highlights:

• Bonds take a break from a continuous 5 week rally; the benchmark bond 6.35% 2020 yield moved to 7.55%, up by 18 bps
• Domestic bond market mirrored US Govt. Bonds; US Treasury bonds’ yields rallied on account of poor consumer spending data
• Liquidity took a major hit; the 3G payments coupled with advance tax outflows put a strain on liquidity
• The RBI announced two liquidity easing measures – additional liquidity support up to 0.5% of banks’ NDTL and 2nd LAF (SLAF) on daily basis
• Call rates and inter-bank rates are likely to go up this week


View & Recommendation:
• With yields easing, fund managers have started increasing the average maturity of income funds, thereby, increasing their ranks in terms of returns.
• Investors looking for investments for a shorter period (6 months - 1 year) should invest in Ultra Short Term Funds (erstwhile called as Liquid Plus Funds) while those looking for a longer investment horizon (1.5 - 3 years) should invest in Income Funds.
• Some of the recommended Income Funds are Birla Sun Life Dynamic Bond Fund, ICICI Prudential Income Fund and Kotak Bond Regular Plan.

Broader Perspectives:
Bond Front
Indian bond markets took a break from a 5-week rally mirroring the movements in US Treasury yields and also incorporating the domestic factors such as liquidity crisis. However, the cancellation of weekly auctions looks distant as the government has other payment commitments such as Cash Management Bills worth Rs. 20,000 Cr, Bond maturities worth Rs. 50,000 Cr in July, cut in Treasury Bills auction size limited to Rs. 22,000 Cr along with government funding to Oil Marketing Companies (OMCs) to the tune of Rs. 14,000 Cr.

Earlier, last week, the bonds rallied after an announcement of probable cancellation of bond auctions this week due to liquidity squeeze arising out of 3G outflows and advance tax payments. The 3G outflows alone is sucking liquidity to an extent of Rs. 67,719 Cr.

The 10-year Benchmark Bond 6.35 per cent 2020 yield shot to 7.55 per cent, up by 18 bps over its last week close. The other heavily traded bond 8.20 per cent 2022 saw yields rise by 17bps to 7.80 per cent on weak-on-weak basis. The average trading volume for G-Secs as reported in NDS-OM platform was Rs. 19,985 Cr. Last week, there were 4 trading days only as the banks were closed on Thrusday (May 27, 2010).


Bond Supply
The government auctioned bonds worth Rs. 12,000 Cr. The notified auction amount was Rs. 4,000 Cr, Rs. 5,000 Cr and Rs. 3,000 Cr for 7.38% G-Sec 2015, 7.80% G-Sec 2020 and 8.32% G-Sec 2032 respectively. The bid to cover ratio was highest (2.5 times) in 10-year benchmark paper, the highest traded paper. The cut-off came in at 7.41 per cent, 7.60 per cent and 8.25 per cent respectively. The government will buyback Cash Management Bills worth Rs. 20,000 Cr this week.


Liquidity Desk
The liquidity was tight last week on account of 3G auction payments by Telecom Companies. Moreover, the advance tax outflows as expected on June 15 have also started putting strain on Liquidity. To ease the pressure, the RBI announced special measures to provide liquidity in the system. The RBI allowed banks additional support under the liquidity adjustment facility. The Central Bank will conduct two rounds of LAF operations. It also permitted banks to avail support of up to 0.5 per cent of their Net Demand and Time Liabilities (NDTL), the steps which will provide an additional liquidity support of Rs. 20,000 Cr. Both the measures would be applicable till July 02, 2010

 Corporate Desk
Corporate bond yields hardened across the tenors. The AAA, 10-year paper hardened to 8.67% compared to 8.60% compared to last week. The 1-year bond traded at a yield of 6.65 per cent. This week, corporate bonds’ yields rose less than the government bond yields. The ten-year benchmark AAA spread shrank to 96bps, down by 14 bps. Corporate bond yields are likely to move higher on account of liquidity worries and interest rate spikes.

Yields softened on robust 3G collections and global cues

Highlights:


• Bond yields rallied for the fifth week straight; 10-year benchmark bond 7.80% 2020 settled at 7.37%

• Euro zone crisis continues to led to flight to safety; funds flowing in to US

• 3G auctions fetched Rs. 67,719 crore to government exchequer, much higher than the government expectation of Rs. 35,000 crore; Broadband wireless auction to fetch another Rs. 15,000 crore too

• Comment from a Senior Finance Ministry official that approval of hike in ceiling on FII’s investment in Sovereign Bonds cheered the bond market during the week

• Liquidity remained comfortable; stood at a daily average level of Rs. 42,779 Cr against Rs. 28,749 Cr reported last week

• The 1-10 year YTM spreads decreased by 21 bps to 254 bps

• Government resorted to 28-day Cash Management Bills again over and above its scheduled weekly auction showing that government’s finances are still under pressure

View & Recommendation:

• G-Sec markets are likely to take cues from policy maker statements and will closely watch the Euro Zone for any developments.

• Markets at shorter end of the curve are expected to take cues from liquidity in the system as 3G outflows might put pressure on short term rates.

• The front end of Corporate Bond curve (1 – 5 years) seems to more attractive compared to overnight rates.
Broader Perspectives:

Bond Front

Indian bond markets rallied for the fifth week straight mirroring the US Treasury yields and also on account of positive cues from the domestic market. Higher than expected 3G auctions collection to the tune of Rs. 67,719 Cr along with comments from RBI Governor and Planning Commission Deputy Chairman that the government may cut down its borrowing in FY 2010-11 aided the rally in bond prices. Moreover, European Debt Crisis including ban on naked Short Selling on selective instruments by Germany led to flight to safety, triggering down the US, UK yields. US Treasury yields also fell due to higher than expected unemployment rate. On the last day of week, the 10-year benchmark bond 7.80 % 2020 settled at 7.37 per cent, a fall of 12 bps against last week close of 7.49 per cent. It touched its weekly low of 7.32 per cent. Global risk appetite battered after Germany banned naked short-selling on selective Euro Zone bonds, triggering fears that there may be more trouble from the region in the days to come.
Inflation Front

On the economy front, the inflation continues to worry government with both its indicative tools i.e. Wholesale Price Index (WPI) and Consumer Price Index (CPI) at double digit level. However, Planning Commission Deputy Chairman asserted that India’s Inflation as measured by WPI may fall further in coming 2-3 months. The market is expecting that the softening of yields including softened inflation numbers in coming months may prompt RBI to stall its exit from accommodative monetary policy. Earlier, the RBI has indicated that they will continue to exit from accommodative monetary measures on a regular basis in the face of demand led pressure on inflation. India’s annual inflation rate based on CPI for Rural Labourers fell to 14.96 per cent in April from 15.52 per cent in March. Primary articles inflation also cooled down to 16.19 per cent in the week ended May 08 from 16.76 per cent a week earlier, however, the food articles inflation jumped to 16.49 per cent from 16.44 per cent in the previous week.
Bonds Supply

The government auctioned bonds worth Rs. 13,000 Cr which were subscribed fully with no devolvement to Primary Dealers. The auctioned bonds were 7.02% 2016, 8.20% 2022 and 8.26% 2027 for amounts of Rs. 5,000 Cr, Rs. 5,000 Cr and Rs. 3,000 Cr respectively. The cut-off yields came in at 7.29 per cent, 7.64 per cent and 7.97 per cent respectively. The bid to cover ratio in 8.26% 2027 were around 2.5 times while remaining bonds witnessed subscribing little below 2 times. Moreover, the auctions of these relative liquid bonds added an increasing interest among dealers and buyers. The government also issued 28-day Cash Management Bills (CMB) at an average yield of 3.9225 per cent.
Liquidity Front

Liquidity as measured by bids for reverse repo/repo in Liquidity Adjustment Facility (LAF) remained comfortable. The reverse repo bids averaged Rs. 42,779 Cr from Rs. 28,749 Cr in the previous week. The liquidity may be under strain following the FIIs outflows in term of Portfolio Outflows and payouts for 3G auction bids. The average call rates and repo rates softened to 3.72 per cent and 3.40 per cent from 3.79 per cent and 3.47 per cent a week earlier respectively.
Corporate Bonds Front

Corporate Bonds saw spread closing up. Five and Ten year’s benchmark AAA spreads closed up by 3 bps at 80bps and 109 bps levels respectively. The ten year AAA bond traded at a yield of around 8.60 per cent, lower from 8.68 per cent observed last week.

Domestic bond yields take cues from US, UK

Highlights:
• Ten year benchmark bond 7.80 per cent 2020 closed at 7.49 per cent touching its Dec figures, down by 15 bps from 7.64 per cent reported last week
• US $ 1 trillion EURO and IMF rescue package to Euro-Zone failed to cheer the world market post announcement
• Flight to Safety witnessed where the money moved out of emerging markets and fled back to US, UK and Germany bonds; yields touched their six-month lows
• India’s headline inflation as measured by Wholesale Price index (WPI) eased to 9.59 per cent in April from 9.9 per cent a month ago
• Liquidity traded at a daily average level of Rs. 28,749 crore
• Income category funds saw an inflow of Rs. 1,77,773 lakh crore in April as compare to an outflow of Rs. 1,64,487 crore as per the data released by AMFI

View &Recommendation:
• Bond yields continue to move down tracking the spurt in buying of US, UK and Germany bonds. The Euro crisis failed to settle down even after the announcement of a rescue package of US $ 1 trillion by other European Union and IMF. The shock waves sent by Euro zone are affecting the currency markets which may lead to a fall in EURO. Equity markets too fall in line with all major world indices going southwards.
• Looking forward, the lower end of the yield curve will continue to trade in range bound. However, in long term, the bond yields may witness upward revisions due to continuous supply of papers.
• The top recommended funds in Ultra Short Term category (erstwhile called as Liquid-Plus Funds) are IDFC Money Manager – Invest Plan – Plan A, HDFC Cash Management Fund – Treasury Advantage and Kotak Floater Fund while in Liquid Fund category, the recommended schemes are HDFC Cash Management Fund – Savings Plan and Reliance Liquidity Fund.

Broader Perspectives:
Though India’s headline inflation figure based on Wholesale Price Index (WPI) narrowed to 9.59 per cent in April from 9.90 per cent a month ago, the government continues to worry from the high figures. The Chief Economic Advisor says that Inflation will continue to fluctuate over the next three months before it starts falling steadily. The WPI topped the 10 per cent mark for the first time in 15 months in February. The higher than the expected inflation put upward pressure on yields. The Industrial Output data as measured by Index of Industrial Production (IIP) slid to 13.5 per cent in March against the market expectation of 15 per cent; manufacturing output grew 14.3 per cent in March compared with 16.1 per cent in February.
The benchmark bond 7.80 per cent 2020 yield dropped below 7.50 per cent level. It closed at 7.49 per cent touching its December figures, down by 15 bps from 7.64 per cent. The G-Sec spread of 10-5 years maturity bonds narrowed to 23 basis points from 27 bps a fortnight earlier. However, the 5-1 year spread widened to 214 bps from 165 bps reported last fortnight. G-Secs rallied following a fall in US Treasury yields, lower IIP and WPI figures. The most traded G-Sec 8.20 per cent 2022 saw yield falling to 7.74 per cent, down by 11 bps. The higher than the expected revenue from 3G auctions will help reducing the high borrowing program. The government is expected to raise Rs. 50,000 crore as against the expected figures of Rs. 35,000 crore. If 2G recommendations as suggested TRAI are implicated by the Telecom Ministry, the government will add additional revenue to its chest. The government issued Cash Management Bills of worth Rs. 6,000 crore at a cut-off yield of 3.87 per cent to pay off its bond redemptions.

The week saw an auction worth Rs. 12,000 crore of Government Securities namely 6.85% G-Sec 2012 (Re-issue), 6.35% G-Sec 2020 (Re-issue) and 8.26% G-Sec 2027 (Re-issue) for a notified amount of Rs. 5,000 crore, Rs. 5,000 crore and Rs. 2,000 crore respectively. All the securities were auctioned off successfully at cut-off yields of 7.24 per cent, 7.54 per cent and 8.22 per cent. There was no devolvement to Primary Dealers. However, the appetite among bond buyers seems to be dampened as the bid to cover ratio slipped below 2X despite a strong bond rally. The 10-year benchmark paper was subscribed to an extent of 1.58 times only. However, there was a strong demand on shorter tenure paper. The bond 6.85% 2012 was subscribed by around 3 times.
Liquidity as measured by bids for reverse repo/repo in the LAF (Liquidity Adjustment Facility) averaged Rs. 28,749 crore against last week average of Rs. 55,491 crore. Banks were also reluctant to lend to each other following weak credit sentiment in the market. The average Call and CBLO rate increased to 3.79 per cent and 3.68 per cent from 3.74 per cent and 3.32 per cent reported last week.

Interest Rate futures - Managing Interest Rate Risks

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Interest Rate futures - Managing Interest Rate Risks

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New benchmark yield 7.80% 2020 closed 5 bps down

New benchmark yield 7.80% 2020 closed 5 bps down

Highlights:

·         Introduction of a new benchmark yield 7.80% 2020; yield cut-off at lower than the market expectation of 7.85%

·         US Treasury yields traded down due to flight to safety after funds started moving out of emerging economies in lieu of Greece’s Fiscal woes

·         Comfortable liquidity in the system; averaged Rs. 47,227 crore over the week

·         Effective G-Sec borrowing to be little over Rs. 38,000 crore; bonds worth Rs. 26,876 is likely to retire this month

·         Six year G-Sec 7.02% 2016 emerged as the most traded security with average volume of Rs. 5,482 crore

·         Inflation based on Primary Articles moderated to 13.55 per cent against 14.14 per cent reported last week

View & Recommendation:

The sentiment is likely to be positive in bond markets; yields may move down further following surplus liquidity, positive MET forecast, low inflation (in weeks ahead), increased and improved inclination for government bond supply. Corporate bonds have seen their spread shrinking further due to increased FII’s buying interests and many other bond deals pipelined in the weeks ahead. Investors having investment horizon of 6 months to 1 year should invest in Ultra Short Term Funds. Once benchmark bond yields stabilizes at 8 to 8.25% levels, long term investors can consider shifting to Income Funds.

Broader Perspective:

Throughout the week, the benchmark G-Sec 6.35% 2020 lost its significance in the wake of announcement of new benchmark yield. It lost its liquidity and the six-year paper 7.02% 2016 emerged as the highest liquid paper with an average weekly volume of Rs. 5,482 crore. Last week, RBI conducted the auction of “7.38% 2015”, “8.28% 2032” and a new “Ten Year benchmark” for a notified amount of Rs. 5,000 crore, Rs. 2,000 crore and Rs. 5,000 crore respectively. The new 10-year benchmark paper received the highest bidding interest with bid to cover ratio of almost 4 times. The RBI fixed the cut-off yield at 7.80 per cent as against the market expectation of 7.85%. Soon after the yield fixation, the benchmark G-Sec slipped 5 bps and closed at 7.75% on account of bullish sentiments and easy liquidity. The bullish sentiment was further supported by a fall in US Treasury Yields as funds moved out of emerging economies on account of Greece’s sovereign crisis leading to Flight to Safety. Standard & Poor has downgraded Greece’s credit rating to Junk and cut Portugal’s rating by two notches to A-minus. It also cut its ratings on Spain by one notch to AA from AA-plus.

This week, the RBI is going to borrow Rs. 15,000 crore. Moreover, the government will also require paying to Oil Marketing Companies (OMCs) for making up the losses out of subsidies borne out by them. Though the government has expected to raise more than the budgeted Rs. 35,000 crore, the government’s financial strain is continue to worry.

RBI Governor D Subbarao said that high inflation was a big worry for the economy and the central bank would take calibrated approach in unwinding the accommodative measures. He also acknowledged that there could be crowding out of the private sector’s credit needs. Further, Deputy Governor Dr. K C Chakrabarty commented that RBI had not issued an extension to all banks to achieve 70% provision cover and would treat banks’ request on case-to-case basis.

On the liquidity front, the liquidity as measured by bids for reverse repo/repo under LAF (Liquidity Adjustment Facility) averaged Rs. 47,227 crore last week. The average CBLO rates spooked to 3.56 per cent from 2.99 per cent reported last week; however, the average CBLO volume declined to Rs. 47,445 crore from Rs. 51,112 crore reported last week.

Corporate bonds saw yields moving down last week. The 5- and 10-year corporate bond closed at 8.20 per cent and 8.70 per cent. However, the spread over G-Sec moved up by 13bps and 24 bps in 5- and 10- year corporate bonds respectively.

RBI’s ‘baby steps’ instead of ‘big leap’ favoured the bond market

Highlights:


• RBI announced policy rate hikes; Repo, Reverse Repo and CRR hiked to 5.25 per cent, 3.75 per cent and 6 per cent respectively, up by 25 bps

• RBI followed “baby steps” instead of “big leap” as a part of unwinding accommodative measures

• RBI’s M3 growth, Deposit Growth and Credit off-take projected at 17 per cent, 18 per cent and 20 per cent respectively for Fiscal Year 2010-11

• CRR hike of 25 bps drained out Rs. 12,500 crore from the system; liquidity still abundant with weekly average of above Rs. 48,000 crore

• Bond Markets reacted positively to RBI announcements; Yields moved down. Benchmark G-Sec 6.35% 2020 settled at 8.06 per cent or Rs. 88.64; Introduction of new security G-Sec 8.20% 2022

• Bond Markets remained buoyant throughout the week following the RBI’s announcement of policy rate hikes.

• Inflationary pressures (food including non-food) and overseas cues such as US Treasury Yields and Crude Oil Prices may also influence domestic bond yields
View & Recommendation:

The policy rate hike is unlikely to put any large impact on short-term yields due to abundance liquidity in the system. The high steepness at the shorter end (1-5 years) of the yield curve may prompt fund managers to roll-down the yields to generate extra returns provided the yield curve does not move significantly. Liquid Funds and Ultra-Short Term Bond Funds will continue to be preferred for investors having investment horizon of 1-3 months and 3-9 months respectively. Investors should avoid investing in high average maturity funds and should restrict investments to funds having average maturity up to 1 year. Short Term Income Fund will fill the void in this category.
Broader Perspective:

The bond markets reacted positively at RBI’s Annual Policy for Fiscal Year 2010-11. The RBI’s calibrated approach in exiting accommodative measures announced during the crisis period of 2008 and early 2009 was welcomed by traders as RBI announced 25 bps hike each in CRR, Repo Rate and Reverse Repo Rate, lower than the market expectations of 50bps. The RBI seemed more concerned on Inflation front and accordingly shifted its actions to inflation-led, thus, giving a balanced approach to Growth-Inflation dynamics. However, the markets could not cheer for the later part of the week and yields moved northwards across the curve in the following days. High Inflation pressure, large week-on-week gilts supply including overseas cues such as US Treasury Yields and Crude Oil Prices has continued to weigh on the gilt prices. However, the better-than-expected 3G auction sentiments (The government hopes to collect Rs. 50,000 crore than its expectation of Rs. 35,000 crore), positive MET forecast of normal monsoons and lower than expected net borrowings (Rs. 25,000 crore net of redemptions) in the month of May can keep the sentiments positive.

During the week, the benchmark G-Sec 6.35% 2020 lost its significance and reported very thin volume as it got replaced by G-Sec 8.20% 2022 amid expectations that the RBI will announce a new benchmark next month. The 10-year 6.35% 2020 and 8.20% 2022 yields moved down. While the benchmark yield settled at 8.06 per cent, 2 bps less than the previous week close, the new G-Sec 8.20% 2022 lost 16 bps since its inception. Traders feared that 6.35% 2020 supply would either shrink or stop and volume shifted to G-Sec 8.20% 2022. Apart from this, the RBI successfully auctioned bonds worth Rs. 12,000 crore – the 7.02% 2016 for Rs. 6,000 crore, the 8.26% 2027 for Rs. 3,000 crore and the 2020 Floating Rate Bond for Rs. 3,000 crore. The RBI sold its first floating rate bond in this fiscal year 2010-11. Floating rate bonds are preferred by investors as the coupon is adjusted every six months, allowing to avoid booking nominal losses in their books. The RBI also announced that it would announce auction results of gilts on the following Monday of auction week instead of Friday of same week.

Liquidity as measured by bids for reverse repo/repo under Liquidity Adjustment Facility was comfortable with bids averaging Rs. 48,738 crore. The coming week may see a slight contraction in liquidity following Rs. 12,500 being drained out as a part of hike of CRR.

Corporate bonds also saw its credit spreads shrinking. Five- and Ten-year spreads dropped by 18 bps and 10 bps to 52 bps and 53 bps respectively. The 10-year AAA Corporate Bond yield closed at 8.75 per cent, a loss of 12 bps.

MF Industry saw a dip of Rs. 1.53 lakh cr; Equity also saw outflows

Indian Mutual Fund industry suffered a major jolt at the concluding month of fiscal year 2009-10. The Asset Under Management (AUM) for the month of March stands at Rs. 6,13,979 crore, a loss of Rs. 1,52,890 crore or 19.94 per cent over its last month figures. The industry saw a net outflow of Rs. 1,52,890 crore against a gain of Rs. 6,365 in the month of Feb. The Income category saw a maximum outflow of Rs. 1,64,487 crore or a loss of 34.57 per cent. Last month, this category had seen a net inflow of Rs. 4,887 crore. However, the Liquid/Money Market category has shown an improvement over its last month figures. The current month saw a net inflow of Rs. 3,971 crore. In Income Fund category, there have been net outflow as the banks have redeemed their investments from Mutual Funds following strict directives from RBI and SEBI. The major surge in Mutual Fund Industry AUM has been happening due to increased participation from banks. They have been keeping their surplus money with Mutual Funds as the credit off-take has been slow following the bleak economic. However, in the month of March, banks have reduced their Mutual Fund positions from Rs. 1,09,453 crore as on Feb 26, 2010 to Rs. 55,502 crore as on Mar 2010. In March 2009, the banks have total investments of Rs. 36,781 crore in instruments issued by Mutual Funds. Last year in Dec 2009, RBI issued a directive to all banks after banks increased their total investments in Mutual Funds to Rs. 1,69,236 crore. RBI argued that the money invested in Mutual Funds have been revolving in the system in the form of Certificate of Deposits (CDs) which banks have been placing with Mutual Funds. The category added three new income fund schemes. JP Morgan India Short Term Income Fund and Sundaram BNP Paribas Monthly Income Plan – Conservative & Aggressive were new schemes added.


On the other front, the Equity category AUM rose to Rs. 1,74,054 crore in Mar 2010 in comparison to Rs. 1,68,672 crore recorded last month, up by 3.19 per cent. However, in terms of total flows, it saw a net outflow of Rs. 2,016 crore. In the month of March, Fund Managers booked profits seeing stretched valuations of stock market. Moreover, they also distributed dividends rampantly. SEBI also banned the dividend distribution out of Unit Premium Reserve (UPR). It said that the dividend distribution amount must be from the profits booked by the scheme. Since the ban of entry loads, equity category has seen a constant outflow of its assets. However, the first two months of 2010 had seen some inflows. In fiscal year 2009-10, the equity category has seen a net inflow of Rs. 595 crore only. However, the overall Mutual Fund AUM has grown 47.13 per cent in FY 2009-10. Bharti AXA Focussed Infrastructure collected Rs. 41 crore from its NFO.

The ELSS category saw its maximum inflow in last 15 months. The category added Rs. 641 crore to its kitty. The inflows had been mainly due to tax-season month where investors put their money in ELSS to get tax rebate under Sec 80C of Income Tax Act 1961. It saw a total inflow of Rs. 1,554 crore in last one year.

The ETF category saw some major outflows in other ETFs category. While Gold ETF added Rs. 45 crore to its kitty, other ETFs category saw an outflow of Rs. 439 crore. Current the total AUM stands Rs. 957 crore, a loss of 28.69 per cent over its last month figures. Two ETFs were added to the category. Religare Gold ETF garnered Rs. 19 crore in its NFO period while Hang Seng Benchmark Exchange Traded Scheme added Rs. 55 crore from its NFO. Hang Seng ETF is the first international ETF being launched in India by Benchmark Mutual Fund.

Gilts saw a net inflow of Rs. 267 crore. Its AUM rose to Rs. 3,395 crore in the month of March 2010, a gain of 7.06 per cent over its last month figure. Given high borrowing programme, bond yields are poised to rise further. The category may saw some inflows in the months to come once the benchmark yield level reaches to 8.25 per cent to 8.5 per cent.

The industry also saw a herd of FMPs in the month of March 2010. A total of 69 schemes were launched which collectively garnered Rs. 14,642 crore. FMPs have seen a comeback after a brief lull. March sees the maximum numbers of new NFOs in FMP category as these products are launched mainly to avail the double indexation benefit, thus, minimizing the tax burden to investors on income earned.

Bond yields laddered to 8 per cent level on devolvement

Highlights
• Benchmark bond 6.35% 2020 yield touched to 8.01 per cent on account of devolvement* in first week auction
• Primary dealers had to devolve Rs. 448 Cr. of 6.35% 2020 paper
• Food inflation rose to 14.50 per cent for data on Mar 27, 2010 against 13.86 per cent observed a week before
• Limits for Ways and Mean Advance (WMA) set at Rs. 30,000 Cr. for first half of FY and Rs. 10,000 Cr. for second half of FY
• Inflationary pressures (data to be available next Thursday) and Industrial Output data to influence the policy review due on April 20, 2010; inflation likely to be in double digits
• Market to witness an auction of Rs. 13,000 Cr. on Government Securities and Rs. 5,800 crore of State Development Loans (SDL) this week

*Devolvement - is a mechanism used by Reserve Bank of India as part of its monetary policy to counter the volatility in the price of Government Securities. Under this mechanism Primary dealers would have to absorb the underwritten amount, when the bid prices are unacceptable to the RBI.

Views & Recommendation:

• The weekly bond issuances are likely to impact the bond prices in a greater way; any further devolvement will put pressure on bond yields.
• Liquid Funds and Ultra Short Term Funds (erstwhile called as Ultra Short Term Funds) would see its yields rising from the current yield as shorter end of yield curve is likely to move up in near future once the policy rates go up.
• Investors having longer investment horizon (more than 2 years) should wait for yields to reach to 8.25-8.5 per cent level and can then invest in Income Funds.

Broad Perspective:

The week started with a cooling in bond yields; the 10-year benchmark 6.35% 2020 G-Sec slipped to 7.80 per cent on Monday, down by 5 bps over its last week closing. However, the sentiments went against the market and the yields rose to its three week highs ahead of first week auction of Rs. 12,000 crore and monetary policy tightening to contain high inflation.
The auction results disappointed the market and the benchmark yield passed 8 per cent mark to close at 8.01 per cent on account of devolvement. It touched to 8.03 per cent level, its highest in more than 17 months and a level it touched on Mar 22, 2010. The auctioned bonds got timid response and primary dealers had to devolve Rs. 448 crore of 6.35% 2020 paper. RBI set the cut-off yield of 7.9645 per cent for the 6.35% 2020 bonds. The other bonds were fully subscribed amidst high demand. Both received demands for more than two times. Due to devolvement, primary dealers demanded high cut-off yields. This week, the choice of securities will decide the momentum of bond yields and primary dealers will demand higher underwriting fees and higher yields in fear of devolvement of securities. Moreover, the subdued response on 6.35% 2020 bond is putting pressure on its existence as the benchmark yield and traders have been demanding for a new benchmark so that they could concentrate on the movement on interest rates instead of choice of a benchmark bond.
Inflationary pressures continue to remain intact; food prices accelerated for second straight week. The inflation based on primary articles rose to 14.50 per cent for the week concluding on Mar 27, 2010 against 13.86 per cent observed a week before. Industrial output data for February due on Monday and March inflation data on next Thursday are the factors which will decide the direction of RBI Policy review due on April 20, 2010.
Liquidity as measured by bids for reverse repo/repo at the Liquidity Adjustment Facility auction went to an average level of Rs. 1 lakh crore against Rs. 2,000 crore reported last week. Overnight rates also remained at the level of reverse repo rates due to high liquidity in the system.
However, Corporate Bonds yields saw an increased activity in the trading circles. Its spread over its counterpart G-Sec slipped in all categories. The 5-year and 10-year corporate bond spread over its counterpart G-Sec slipped to 76 bps and 63 bps from 81 bps and 82 bps respectively. The 10-year Corporate Bond closed at 8.80 per cent for the week concluding on April 09, 2010.
RBI set the limit for Ways and Mean Advance (WMA) at Rs. 30,000 crore for first half of fiscal year (April to September) and Rs. 10,000 crore for second half of fiscal year (October to March). WMA is a window through which the government borrows from RBI to meet mismatches between payment and receipts. Any borrowing within the WMA limit is done at Repo rate and over the WMA limit, it is done at Repo plus 2 per cent.

MF Industry assets grew 51.6 per cent y-o-y

Highlights:
• Mutual Fund Industry assets grew 51.6 per cent on year-on-year basis; shrink by 4.6 per cent on month-on-month basis
• The AAUM touched Rs. 7.47 lakh crore as on Mar 2010; saw its historical high of Rs. 8.07 lakh crore in Nov 2009
• Reliance Mutual Fund (Rs. 1.1 lakh crore) continues to be the top fund house in terms of AUM
• SEBI dedicated fiscal year 2009-10 for investors bringing in many regulatory changes which changed the mutual fund industry trends
• Equity funds saw major outflows after the ban of entry loads
• Liquid Funds/Income Funds/Ultra Debt Short Term (erstwhile called as Liquid Plus Funds) will continue to see the inflows given the uneven interest rate scenario in near future

The fiscal year 2009-10 ended into a happy note with Mutual Fund Industry assets growing 51.6 per cent year-on-year. The industry added a total of Rs. 2.54 lakh crore to its kitty with total Average Assets under Management (AAUM) of Rs. 7.47 lakh crore. The year also saw Mutual Fund AUM’s historical peak of Rs. 8.07 lakh crore as on Nov 2009. However, it lagged the bellwether indices Sensex and Nifty 50 which clocked 80.54 per cent and 73.76 per cent returns respectively for the fiscal year 2009-10. On monthly basis, the Mutual Fund Industry Assets slipped to Rs. 7.47 lakh crore or a loss of 4.6 per cent over its Feb end of Rs. 7.82 lakh crore. The Feb month saw a hike of 2.64 per cent on monthly basis.
Reliance Mutual Fund continues to top the chart with AAUM of Rs. 1.10 lakh crore with a hefty gain of 36.4 per cent. The other leading fund houses in terms of AAUM are HDFC Mutual Fund (Rs. 88,780 crore), ICICI Prudential Mutual Fund (80,989 crore) and UTI Mutual Fund (Rs. 80,218 crore). On absolute basis, the fund houses which saw windfall gains are UTI Mutual Fund (Rs. 31,463.6 crore), HDFC Mutual Fund (Rs. 30,823.4 crore), ICICI Prudential Mutual Fund (29,556.3 crore) and Reliance Mutual Fund (Rs. 29,450 crore). The massive increase in AUM was mainly due to inflows in Debt/Income/Liquid/Liquid Plus categories. However, equity had a net outflow after SEBI banned entry loads post Aug 2009.
The fund houses which saw maximum decline on month-on-month basis are JP Morgan Mutual Fund (-31 per cent), AIG Global Investment Group Mutual Fund (-24.9 per cent), Deutsche Mutual Fund (-19.5 per cent) among others. The prominent gainers in double digits were Peerless Mutual Fund (60 per cent) and Edelweiss Mutual Fund (23.3 per cent).

Yields to reel under inflationary pressures; rate hikes imminent

Highlights:

• Government borrowing schedule of massive Rs. 4.57 lakh crore declared; 63 per cent of total borrowings are front-loaded in first half of fiscal year 2010-11.


• On an average, the weekly borrowing would be in the range of Rs. 11,000 to Rs. 13,000 crore; the May month may witness the maximum borrowing of Rs. 65,000 crore with minimal borrowing of Rs. 22,000 crore in September.


• No Open Market Operations (OMOs) transactions declared; unlikely to put any pressure on yields due to sufficient liquidity.


• The week saw a sudden yearend decline in bond yields following the borrowing schedule declaration; unlikely to sustain the spurt in bond prices.


• Inflationary pressures to continue putting pressures on bond yields.


• The 10-year benchmark G-Sec 6.35 % 2020 to trade in the range of 8-8.5 per cent for most of the year.


• There was a combined transaction of Rs. 9,540 crore under Repo Facility in the last 3 days of Fiscal Year 2009-10.


• The G-Sec spread between 1-5 years have widened to 238 bps from 227 bps in the previous week.

Views & Recommendation:

·         For few weeks, the market may absorb the bond issuances without any impact on yields but in long term, the bond yields may witness upward revisions.

·         The short-tenure bonds would be in demand in the month of April and May in the current fiscal year due to negligible issuances. This may lead to unexpected hike in prices of short to medium term papers. An opportunity lies ahead in booking profits in short-to-medium term bonds/Income Funds/Short Gilt Funds after a couple of months.

On return basis, Tata G S S M F – Growth (6.67%), UTI G Sec Fund – STP – Growth (5.06%) among others has been front runners under Short-term Gilt Funds in two-year category. 

·         Liquid Funds and Ultra-Short term Debt Funds (erstwhile called as Liquid-Plus Funds) will continue to see inflows as investors would continue putting their surpluses for a short duration.

Broader Perspective:

The market reacted positively on the announcement of Government Borrowing Schedule; about 63 per cent of total borrowings (Rs. 2.87 lakh crore) are front-loaded in the first half of fiscal year 2010-11. Thus, it would prevent crowding out for private firms as post-October used to be busy borrowing month for them. The market will see an average weekly auction of Rs. 11,000 – Rs. 13,000 crore. The benchmark bond 6.35 per cent 2010 yield saw some swings.  The yield fell from 7.85 per cent to as low as 7.74 per cent before closing at 7.85 per cent level again. The 10-year benchmark G-Sec price closed at Rs. 89.90 down from Rs. 90.30 level as on Mar 30, 2010. Bond Prices and Yields move in opposite direction.

The high inflationary pressure is on the top agenda of policy makers as they are closely scrutinizing to negate its effects on yields since it would increase their borrowing costs. The inflation as measured by Wholesale Price Index (WPI) has already touched 9.89 per cent for the month of Feb 2010 and the March figures may touch the double digit. Though the government officials are of the view that inflation would drop down in couple of months citing the high base effect and falling food prices as the prominent reasons, it will continue haunting on non-food sides. The high crude prices including the high petrol and diesel prices for EURO IV vehicles will add pressures to inflation further.

The market may factor into the weekly bond supply and will see a smooth transition of bonds for first few weeks but the yields may harden in the weeks to come citing the absence of any Open Market Operations (OMOs) from the government side.

The other bonds 7.02% 2016 and 7.32% 2014 saw yields moving up 13 bps and 1 bps to 7.59 per cent and 7.25 per cent levels. Corporate bonds also saw yields dropping down. The shorter end of the curve saw yields falling piercingly after March-end liquidity worries went out of the system. The last three days of the fiscal year 2009-10 saw a total repo transaction of Rs. 9,540 crore under Liquidity Adjustment Facility (LAF). The liquidity as measured by Reverse Repo transaction under Liquidity Adjustment Facility (LAF) remained tight with an average volume of Rs. 4,027 crore.

New Mutual Fund regulations to benefit investors

The Mutual Fund Industry has a happy ending in 2009 with assets growing to a fabulous high. The industry also saw some investors’ friendly regulations turning to be unfriendly for distributors and IFAs. Starting from No-Load scenario post Aug 01, 2009 to host of other regulations, SEBI threw another set of regulations to all fund houses in the month of March 2010 signaling another round of reforms in world’s fastest growing Mutual Fund industry.

 

Reduction of NFO’s Period

Starting with the list, SEBI reduced the New Fund Offers (NFOs) duration to a maximum of 15 days from 30 days for open-ended funds and 45 days for close-ended funds. On completion of NFO period, the units’ allocation and dispatch of Statement of Accounts (SoAs) are required to be done within five business days after the closure of NFO period. The rule also says that Mutual Funds shall make investments out of NFO proceeds only on or after the closure of the NFO period. The new rule is effective from July 01, 2010.

 

Introduction of ASBA for MF Investors

SEBI introduced ASBA or Applications Supported by Blocked Amount in July 2008 for all equity investors investing in IPOs or Right Issues to make effective use of money put into it. Under this, the application money you put for subscribing to IPOs/Right Issues does not leave your bank account unless the allotment is done. So, there is no need for refund of money, thus, reducing the operational issues and you also earn interest even on blocked amount. Now, this facility is extended to Mutual Fund investors putting money in NFOs. Nevertheless ASBA means little for investors as most investors put money only on the last day of NFO period. Moreover, SEBI has mandated that the fund house has to allot units five days after the closing of NFOs.

 

Dividend distribution from realized profits

SEBI also mandated that the dividends to be paid to investors have to be out of realized profits only. Currently, some Mutual Fund houses pay dividends from their Unit Premium Reserve instead of booked profits. E.g. A fund XYZ has an initial NAV of Rs. 10. The amount Rs. 10 goes to an account called as Unit Capital or Face Value. Let us say the NAV grows to Rs. 15. The appreciation amount of Rs. 5 goes into a separate account called as Unit Premium Reserve (UPR). This ruling might affect many fund houses which used to declare dividends as a marketing gimmick to attract inflows. After this ruling, many fund houses have cancelled the dividends declared.

 

FoFs commission to decline

In case of FoFs, AMCs have been entering into revenue sharing agreements with offshore funds in respect of investments made. Typically they get around 50-100 bps from Offshore Funds along with 75 bps which they charge from investors. Out of 75 bps, they used to take care of marketing expense and other expenses. The Fund Houses used to pocket the sharing revenue (50-100 bps) from Offshore or Local Funds where they have invested. Post this ruling, an FoF may not be a profitable avenue for Mutual Funds in India.

 

Adherence to Corporate Governance

Since Mutual Funds invest in companies on behalf of investors, SEBI wants them to be more participating in company affairs and voice their opinions. SEBI has mandated that Mutual Funds must disclose participation in company’ annual or other affairs such as exercising voting rights in mergers, AGMs, changes to capital structure, appointment or removal of Directors, stock option plans and other management compensation issues and many more in their website and Annual Reports.

Following Satyam scam, SEBI wanted the companies to be more accountable for their acts and business rules and Mutual Funds which represent a group of investors will be the best fitted for this role.

 

Conclusion

 Time to time, SEBI comes out with different regulations which ultimately helps retail investors. Thanks to our robust financial system which surpassed the economic crisis of 2008 post Lehman collapse, SEBI wants to ensure that India remains decoupled with financial breakdown which galloped major big names. Moreover, SEBI wants to make MF and its fund managers more transparent and accountable for investors’ money. However, the challenges lie ahead how the fund houses implement these changes. Happy Investing!

 

 

Bond markets awaits borrowing calendar; yields to remain under pressure

Highlights:

•  The 10-year benchmark (6.35 per cent 2020 G-Sec) traded in range bound; closed at 7.85 per cent, up by 2 bps


• The average volume under Reverse Repo remained at Rs. 15,500 crores


• Inflationary pressures to continue; unwinding of accommodative measures by RBI to continue


• Non-food inflation also factoring into the overall inflation figures; will remain high in near term


• Borrowing calendar for the fiscal year 2010-11 to be announced on March 29, 2010; expected to be front-loaded


• Short-term yield curve to remain under pressure; G Sec spread for 5-1 years and 10-5 years at 220 bps and 39 bps respectively

Detailed View:

The policy rate action by RBI post market hours left traders dazzled on Monday and the yield on 10-year benchmark (6.35 per cent 2020 G-Sec) soared to 8.03 per cent, its 18-month peak before easing to 7.85 per cent, up by 2 bps over its last closing. This immediate reaction in the market was inevitable after RBI raised short term policy rates by 25 bps. Post action, the repo rate and reverse repo rate stand at 5 per cent and 3.5 per cent respectively. During the week, the yields on the benchmark G Sec remained in range bound and closed at 7.85 per cent, up by 2 bps. One basis-point is one-hundredth of a percentage point. Traders have been waiting eagerly for the weekly borrowing calendar to be announced on Mar 29 and expect that most of the borrowings are scheduled to be front loaded (60-70 per cent of total gross borrowings) in the first half of the fiscal year. The market will also keep a watch on the tenure of the bond issuances. The government has indicated that it would raise Rs. 4,57,000 crores from market in 2010-11, up by Rs. 6,000 from last year’s gross borrowing. Traders have been demanding short to mid term papers to be the major part of borrowing schedule in first half of the fiscal year following high inflation, unwinding of accommodative monetary policies by the central bank etc.

The RBI has been under high pressure on soaring inflation which is on continuous rise and has already touched near to 10 per cent. The inflation which used to be mainly due to food prices’ factors has moved to non-food prices’ factors too. Fuel inflation soared to 12.5 per cent for the week ended March 13. It might continue to remain high after the recent oil price hike by the government. Manufacturing inflation is also running at 4 per cent level and is expected to remain high as manufacturers pass the rising input costs to consumers.

The yields on 5-year 7.32% 2014 G-Sec rose by 6 bps to 7.24 per cent while 7.02% 2016 yield rose by 8 bps to 7.46 per cent.

On the liquidity front, the liquidity as measured by bids for reverse repo/repo under the Liquidity Adjustment Facility (LAF) remained comfortable with average bids for reverse repo amounting to Rs. 15,000 crores in the concluding week.

View and Recommendations

The yields at the shorter end of the curve will remain under pressure as the market would be witnessing a new round of borrowing next week onwards.
Liquid Fund and Ultra-short term debt funds (erstwhile called as Liquid-Plus Funds) should be the preferred choice for investors looking to invest their surpluses for a short duration (3-6 months) while for an investor having investment horizon of 9-12 months should invest in Income Funds. On return basis, LIC MF Income Plus Fund – Growth, IDFC Money Manager – Invest Plan – Growth and Kotak Floater – LT – Growth have been the front runners in Liquid Plus category in 6-months horizon. In Income Fund category, some of the actively managed funds are Fortis Flexi Debt Fund – Growth, Birla SunLife Dynamic Bond Fund – Retail – Growth and HSBC Flexi Debt Fund – Retail – Growth scoring 10.33 per cent, 8.27 per cent and 7.28 per cent respectively in 1-year category.
New FMPs have been flowing into the market on a continuous basis. Investors looking to lock-in their investments for a longer period (13-20 months) can consider this avenue as they will also get Double Indexation benefit (if invested before March 31, 2010) which will reduce the tax outflow on their FMP earnings.

RBI acts on Repo and Reverse Repo, a surprise for all

Indian Debt Markets are increasingly more on middle-of-the-road as traders awaited the borrowing calendar from RBI anxiously due on Mar 29, 2010. The inflation as measured by Wholesale Price Index (WPI) already reached to 9.89 per cent on month-on-month basis surpassing the RBI projection of 8.5 per cent. This has put policy makers to analyze all the monetary scenarios before announcing a roll back in accommodative measures. The Deputy Governor K C Chakraborty commented that the RBI might take measures anytime before the RBI policy meet on April 20 to tame the inflation which had shifted from Supply Side constraints to Non-food inflation constraints. An increase in non-food i.e. manufacturing inflation coupled with high IIP numbers (already in double digits nearing 16 per cent for two times in a row) prompted the RBI to announce a hike in policy rates, the first step seen in unwinding the stimulus packages and normalizing policy rates to tame the high inflation. The RBI hiked the Repo Rate and Reverse Repo Rate under the Liquidity Adjustment Facility (LAF) to 5 per cent and 3.5 per cent respectively with immediate effect, a hike of 25 bps over its last figures. Repo Rate is the rate at which the banks borrow money from RBI for meeting its short term liabilities and Reverse Repo Rate is the rate at which the banks put their surplus/money with RBI. This unexpected move may increase the sell offs by traders and yields may move northwards.

The inflationary pressures were of high concern as evident from RBI statement “Notwithstanding some moderation in recent weeks, food prices remain at elevated levels. In fact, consumer price inflation, as measured by various consumer price indices, has accentuated further. The acceleration in the prices of non-food manufactured goods and fuel items in recent months has been of particular concern.”  

The 10-year paper benchmark 6.35 % 2020 G Sec cooled off to 7.82 per cent, down by 18 bps week on week while the 5-year paper 7.32% 2014 saw yields slipping to 7.18 per cent, down by 13 bps. The cut-off price for the 91-Day T Bill was seen at Rs. 98.91 or at 4.42 per cent compared to previous cut off of 4.34 per cent. There was also a pressure seen on Corporate Bonds. On the shorter end of yield curve, the spread over G Sec in one-year category rose to 142 bps as on Mar 19, 2010, up by 16 bps. In 10-year category, the spread rose to 90 bps, up by 17 bps. The 10-year AAA bond traded at 8.88 per cent vis-à-vis 8.90 per cent as observed in last week.

Bond market nervous amid advance tax outflows

The Bond Markets traded northwards amid thin volumes. The yields sharpened northwards amid speculation that government will complete 60-70 per cent of total borrowing estimates in first half of the fiscal year 2010-11. Since the bond markets have already factored most of the economic developments related to bond markets, the traders awaited for the borrowing schedule program to be announced on March 29, 2010 by RBI before initiating their plan of actions. High inflationary pressures also dampened the mood among traders. The market is expecting an inflation to remain in the range of 9.5-10 per cent, much higher than the RBI estimate of 8.5 per cent. The banks’ credit growth has also shown encouraging numbers giving a fear among traders that the banks would be forced to subscribe to Government Securities and private firms would be crowded out. The banks’ non-food credit growth has reached 16.8 per cent level, higher from 11 per cent recorded in the month of Dec 2009.
The benchmark bond 10-year 6.35 % G Sec hardened to 8.01 per cent, a hike of 4 basis points (bps) over the last level of 7.97 per cent. One basis point is one-hundredth of a percentage. Index of Industrial Production (IIP) for January grew 16.7 per cent year on year basis, little below the market expectation of 17 per cent. The numbers prompted yields to ascend with 10-year benchmark G Sec to end at 8.01 per cent level. The other securities 7.02 % per cent 2016 saw yields rising to 7.68 per cent, up by 1 bps. The five year 7.32 % 2014 saw yields down by 4 bps to 7.30 per cent level and the 8.34 % 2027 yield dropped 2 bps at 8.38 per cent levels. Corporate bonds yields closed lower on weak to weak basis. The Five- and Ten-year corporate bond yields closed at 8.60 per cent and 8.90 per cent levels respectively. Moreover, the advance tax outflows may cramp the liquidity in the market.

Invest in ULIPs – A good Wealth Creator tool in long term

Out of the blue, the Indian insurance industry is the talk of Dalal Street as it has become a major contributor of investment in the equity market. Though premium collection slowed to some extent in early 2009, it has been gaining pace with the overall healthy market sentiment. Premiums collected under ULIPs are a major driver in boosting equity investment. Renewal premium of the industry in the ULIP category increased from Rs.26,638 crore to Rs.37,543 crore, an increase of 41 percent year-on-year. Insurance companies invested Rs.44,358 crore in equity between April and December 2009.

The practice of mis-selling ULIPs has largely been curbed after the insurance watchdog, the Insurance Regulatory and Development Authority (IRDA) introduced investor-friendly rulings, capping charges up to three percent and 2.25 percent for ULIPs with maturities of up to 10 years and those beyond 10 years, respectively. Moreover, the IRDA ruling on solvency ratio, corporate governance, public disclosures, payment made to intermediaries and allowing unit-linked health insurance plans, have greatly benefited the insurance industry.

How do ULIPs perform well in the long-term?

The major objective of ULIPs is to build wealth, steadily in the longterm as well as providing insurance cover, though investors must be clear that, investing in ULIPs is not to get high insurance cover. A fund manager in insurance companies can hold stocks for a longer period than his counterparts in other industries. Hence, churning in portfolio stocks, measured by Portfolio Turnover Ratio (PTR) is relatively less or negligible. Since churning involves costs, it has a major impact on a fund's performance. Higher the Portfolio Turnover Ratio, higher is the cost involved. Moreover, IRDA's cap on charges including a cap on Fund Management Charges (FMC) in case of ULIPs, bring more benefits to policyholders in the form of increased returns. A close look at the performance of other market related products vis-à-vis ULIPs throws up a startling fact. Other market related products lag ULIPs' returns by a large margin in the long run, which confirms that ULIPs are an ideal investment vehicle for wealth creation in the long term. On an average, the historical FMC in other market related products are lower. For mutual funds they come to about 2.1 percent whereas for ULIPs, the maximum FMC is capped at 1.35 percent.

For example, a periodic investment of Rs.1 lakh in a diversified equity linked fund (ELSS) for 15 years grows to Rs. 28.54 lakh at an assumed growth rate of 10 percent, giving a net yield of 7.69 percent

(Considering an average FMC of 2.1 percent). The same amount invested in ULIP for the same period may range from Rs.28.63 lakh to Rs.31.59 lakh at an assumed growth rate of 10 percent, giving a net yield ranging from 7.97 percent to 9.03 percent. The final value falls further if we consider other tax-saving instruments such as PPF, which gives a return of eight percent a year. An investment of Rs.1 lakh a year in PPF for 15 years grows to Rs.27.15 lakh.

So, clearly, ULIPs score over other products in terms of returns and additional benefit such as insurance cover. But it scores below PPF as an investment in ULIPs involves high risks. Returns on ULIPs rise due to lower FMC if the investment choice is a debt fund and assumed rate of return is 10 percent (in debt funds, the FMC is generally about 0.75-1 percent). The table shows the different returns.

However, the high entry costs and operational costs mar the performance of ULIPs on shorter maturity periods. Thus, we see that ULIPs appear to be the obvious choice for investments for creating considerable wealth in the long term.

SEBI’s ruling on Mark-to-Market may shun the attractiveness of Ultra-short term funds

Since the SEBI made mandatory for Liquid Fund managers to invest in papers with maturity of up to 91 days only, the Liquid Funds lost sheen among institutional investors due to reduced portfolio returns. This allowed the market participants to shift its focus to Ultra Short Term Funds (erstwhile called as Liquid-Plus Funds). Thanks to superior returns and tax benefits over Liquid Funds, Ultra Short term funds have found a favour among all class of investors.

However, the market watchdog SEBI still not very confident about the credit stability in the market issued another directive asking all mutual funds to value money market and debt securities with maturity over 91 days (or with maturity up to 182-days) on a mark-to-market basis with effect from July 01, 2010. The ruling will require all fund managers to factor in any movement in securities prices on a daily basis to calculate the Net Asset Value (NAV) of fund. The new valuation method may increase the volatility of Ultra Short Term Funds while Liquid Funds being shorter tenure funds will be less volatile. Currently securities having maturities over 182 days are already valued at daily weighted average (mark-to-market) method. The move will ensure that the Liquid Funds and Ultra Short Term Funds are undeniably liquid by asking them to be valued in a more transparent manner.

Ultra short term schemes which comprise 40 per cent of Indian Mutual Fund industry’s asset under management (AUM) of Rs. 7.59 lakh crore have been fetching returns in the range of 5-5.5 per cent having an edge over its sibling Liquid Funds fetching returns in the range of 4-4.25 per cent. The debt instruments held by Ultra Short Term Funds (or Liquid-Plus Funds) have a longer tenure i.e. the average maturity of these funds is comparatively higher than that of Liquid Funds. Long term papers (over 91 days) help fund managers to generate extra returns over short term papers (up to 91 days). Recently the RBI hiked the CRR by 75 basis points which increased the returns on Commercial Papers and Certificate of Deposits by around 100-150 basis points.

In the last few months, there have been continuous net outflows from Liquid Funds due to high dividend tax structure and restrictions to invest in papers having maturities up to 91 days only. Liquid Funds charge a dividend distribution tax (DDT) of 28 per cent unlike in Ultra Short Term Funds where the DDT is 14 per cent for individual and 22 per cent for corporate, thus, clearly giving a tax advantage of 8 per cent. Treasury Officials, CFOs etc prefer Liquid Funds and Ultra-Short Term Funds over Banks’ Fixed Deposits where interest income is charged at 33 per cent.

By issuing out the current directive, the regulator SEBI wants to make sure that the Oct 2008 Credit Crisis is not repeated where the RBI has to open a lending window for Mutual Funds for a limited period to ease out the crisis. However, the industry will continue to enjoy additional returns in Ultra Short Term Funds, though at a slightly higher risk as long as the tax-arbitrage is in existence over Liquid Funds and banks’ Fixed Deposits. The market will actively watch the upcoming Annual Budget on Feb 27, 2010 where the government may take away the tax arbitrage in Ultra Short Term Funds to make sure that Banks’ FDs are actively used for placing excessive unused funds, thus, bringing out a kind of stability in the credit market.

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Best of 2009 – Stocks

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