How to make investing in short term debt work for you?
Recently the rupee has bounced back, which has also been helpful to investor sentiment. By reducing demand for dollars, and tightening domestic liquidity & positive steps which will help banks mobilize FCNR deposits, the RBI has succeeded in breaking the arresting the rupee fall.
October 24, 2013 / 11:43 IST
Yadnesh Chavan
Mirae Asset Global Investments (India) Limited
News flow on economic, corporate and liquidity fronts are showing significant deterioration in last three months. This confluence of bad domestic news is the worst in the last decade, which is making investors wary more about their investments. However the past one week has thrown some positive surprises from narrowing trade deficit, strengthening rupee and equity markets and better IIP numbers.Recently the rupee has bounced back, which has also been helpful to investor sentiment. By reducing demand for dollars, and tightening domestic liquidity & positive steps which will help banks mobilize FCNR deposits, the RBI has succeeded in breaking the arresting the rupee fall. While risk and reward go hand-in-hand, in the bond market it’s the type of risk you are taking that counts the most. Investors can easily avoid unnecessary risk by choosing right segment while investing.Typically fixed income investors are exposed to credit risk and interest rate risk. If you want to take advantage of falling rates, be sure that you’re investing in a fund with higher interest-rate risk, not higher credit risk. Currently, the deterioration of corporate financial performance has implications for debt fund investors. In current scenario lower rated corporates are more likely to default than AAA rated corporates. Lower rated debt may offer higher yields, but one must understand that those high yields may themselves be contributing to the financial difficulties of the borrowers.So we feel investors must pay attention to credit quality of debt portfolios and choose portfolios with higher allocation to highest rated debt. The twin measure taken by RBI last month on July 15 2013 and July 23 2013, coupled with the other measures has tightened the overnight liquidity and led to overnight rates spiking to 10.25% and yields across the yield curve rising by 70-300 bps.The yield curve has become “inverted” which means shorter maturity papers are offering higher yield than longer maturity papers.With such a challenging inflation, growth, and exchange rate situation. Looking at the overall policy response of other central banks like Indonesia to the recent currency depreciation it expected that tighter policy stance of RBI will continue. The best the central bank can do is announce more measures to bring in external financing and offer banks/corporates more incentive to address their weak balance sheets. We believe that the overall liquidity and rates will remain unchanged for some more time. Till such a time investors can take benefit of higher yields at shorter end without taking much interest rate risk. Over the period of time yields for the short term and long term papers will get adjusted in response to emerging changes in liquidity and RBI policy stance reacting to the Rupee movement. However long term yields will continue to remain under pressure because of continues supply of government bonds, raising inflation expectation because of Rupee depreciation and worries over fiscal deficit. The large supply of gilts making it dependent on RBI`s support through OMO - purchases in government borrowing. The shorter end of the curve is providing attractive yields resulting into high coupons, also when the situation will start getting normalized will provide excellent opportunity to make capital gains.To summarize, the investors can look to invest in Short Term funds with portfolio duration of 1 to 1.5 preferably with 100% allocation to gilts and AAA rated papers.The author is a fund manager - fixed income at Mirae Asset Global Investments (India) Limited. Discover the latest Business News, Sensex, and Nifty updates. Obtain Personal Finance insights, tax queries, and expert opinions on Moneycontrol or download the Moneycontrol App to stay updated!
