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Positioning of FI Fund July 21 2010

Positioning of FI Fund July 21 2010

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Published by: unw on Sep 12, 2010
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New SEBI ValuationGuidelines & Positioningof DSP BlackRock FixedIncome Funds
July 21, 2010
Preface:
New SEBI norms on Mark-to-Model of non-traded Money Market Assets with residualmaturity of more than 91 days are going to be applicable from August 1, 2010.These new guidelines are aimed at ensuring the valuation of such assets closer tothe prevailing market level, rather than at the carrying cost* as under the currentvaluation guidelines.
Likely Impact:
The new valuation guidelines are likely to result in higher volatility in the daily returnsof some xed income schemes such as Liquid Plus Funds, which predominantly investinto money market assets. These assets will be marked-to model at the prevailing YTMfrom August 1, 2010. Considering the fact that money market yields have gone up inrecent months, we believe that some investments may face price depreciation due toimplementation of these new mark-to-model guidelines. Liquid Plus Funds have beenpreferred investment avenue for institutional investors due to superior tax-adjustedreturns compared to Liquidity Funds. We believe that the likely impact of these newvaluation norms on individual funds will be based on the following factors:• Current YTM of the asset – Lower the YTM, higher will be the impact• Residual Maturity of the asset – higher the residual maturity, higher will be theimpact• Credit Rating of the asset – lower the credit rating of the asset, higher will be theimpact
Investor Reaction:
We believe that most institutional investors are likely to remain cautious ahead of the upcoming Credit Policy due on July 27, 2010 as well as implementation of thenew valuation guidelines. We anticipate that they will possibly switch into LiquidityFunds from Liquid Plus Funds on or before August 1, 2010 as Liquidity Funds do nothave investments with residual maturity beyond 91 days. Therefore, Liquidity Fundsare not likely to get affected at all due to these new norms. We also believe thatinstitutional investors may consider investing in such Liquid Plus Funds that have littleor no exposure to assets with residual maturity beyond 91 days. Institutional investorswill consider investing back into Liquid Plus Funds with assets maturing beyond 91days after they ascertain the impact of the new regulation.
 
DSP BlackRock Fixed Income Fund Positioning:
Keeping in mind these new valuation guidelines and current term structure of moneymarket yields, we have repositioned some of our xed income funds. This repositioningis aimed at articulating our xed income investment strategy in a clear manner. Theyare summarized in the following table:
As on July16, 2010DSPBlackRockLiquidityFundDSPBlackRockMoneyManagerFundDSPBlackRockFloatingRate FundDSP BlackRockStrategic BondFundDSPBlackRockShort TermFundSize
Rs. 1,523croreRs. 685 croreRs. 2,098croreRs. 891 croreRs. 771 crore
AverageMaturity
0.12 years0.14 years0.17 years0.26 years0.25 years
PortfolioYTM
6.18% pa5.99% pa5.55% pa5.57% pa5.95% pa
NewPositioning
No changeDependingon the FundManager’sview theFund mayhave upto 10% of its assetsmaturingbeyond 91daysDependingon the FundManager’sview theFund mayhave upto 25% of its assetsmaturingbeyond 91daysThe Fundwill continueto focuspredominantlyon Bank Assetswith activeportfoliodurationmanagementActiveportfoliodurationmanagement
Exit Load /Lock-in
No Lock-inNo Lock-inNo Lock-inNo Lock-inNo Lock-in
Who shouldinvest?
Creditconsciousinvestorswith STsurplusliquidityCreditconsciousinvestorswith STsurplusliquidityCreditconsciousinvestorswith someappetite forvolatilityCreditconsciousinvestors withsome appetitefor volatilityCreditconsciousinvestorswith someappetite forvolatility
IdealHorizon forinvestment
Up to 1monthUp to 1monthUp to 3monthsUp to 3 monthsUp to 6months
ExpectedDaily ReturnVolatility
LowerLowerModerateModerateHigher
How Should One Invest Going Forward?
 
How Should One Invest Going Forward?
We believe that investors should no longer focus only on the past performance of thefund before making an investment decision. From now on, investors will have to focuson a host of factors before investing in a particular fund in our opinion. Some of themare summarized below:
FactorsRationale
Credit Quality of PortfolioThe new valuation guidelines are now going to value assetsbased on their credit rating and duration. Now, funds willhave to factor in the price impact of purchasing a lowercredit quality asset.Average MaturityThe new valuation guidelines are now going to valueassets based on their credit rating and duration. Higherthe average maturity, higher will be the daily volatilityin returns.Sector AllocationThe new valuation guidelines will now differentiate amongvarious asset classes such as Bank, Corporate, NBFC, ABS,Real Estate etc. and value them appropriately.Fund Manager’s InterestRate ViewsFund Managers will no longer be able to focus only onoptimizing portfolio YTM going forward as assets are nowgoing to be valued daily based on the prevailing termstructure of rates. Their views on interest rates will havegreater bearing on their future performance.Investment HorizonInvestors will have to dene their investment horizonand risk tolerance going forward. We expect daily returnvolatility to average out over time. Therefore, investorswill now have to exhibit some degree of patience in orderto achieve the expected return.
Summary:
To summarize, we believe that Indian xed income fund management is ready totake a giant leap forward in terms of management and investment style. It may takea while but it is denitely going to be good for both the investor as well as for theindustry as these new guidelines will force both the fund manager and investors tothink differently and adapt their existing investment style.
* Carrying cost means at cost plus interest accrued till the beginning of the day  plus the difference between the redemption value and cost spread uniformly over the remaining maturity period of the instruments.

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