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With the rally in G-secs and the flattening of the yield curve, our funds have reduced their exposure to very long maturity.

THE beginning of the new fiscal year saw the continued rally of bond markets wherein there was absolute flattening of yield curve with 10-year yields moving down from 5.16 per cent to 5.06 per cent before correcting to 5.11 per cent levels. The main reason attributed to the flattening of the yield curve has been lack of supply from the government.

However, the government is not issuing very long papers so as to control the systemic risk to any spike in interest rates. Liquidity continued to rule easy throughout the month with money in the LAF system touching a peak of Rs 85,000 crore before easing to slightly lower levels.

In the shorter segment, expectations of cut in the repo rate from the current 4.5 per cent to 4 per cent levels, kept the short-rates bullish.

Big inflows into money market funds and very little supply of corporate papers in the short-end were cited as reasons for the run-up.

This rally has led to incremental investments being made at lower levels pulling the yields down. Inflation continued to rule steady at around 4.4per cent.

The recent drop in commodity prices, mainly metals, should bring in some relief to the ever-soaring prices.

However, the global scenario has been pointing towards a hardening of interest rates for some time. In the US, for example, on reports of better GDP growth and employment, interest rates moved up by 50 basis points.

In his statement to Congress, the Fed Chairman, Mr Alan Greenspan, broadly indicated that rates should rise, but left the timing guessing. The popular view is that the Fed would like to see a sustained improvement in the economic fundamentals before moving in to hike rates. Corporate bond markets remained positive with spreads tending to move down during the first fortnight. The ten-basis spread shrinkage reversed last week, along with correction in G-sec market, taking the spreads back to the previous month-end levels.

Monthly Income Plan

Our strategy for equity portion of MIP has been to conserve capital. This has resulted in the equity exposure never exceeding 10 per cent since inception, as equity markets have been volatile during this period. We have prudently played the IPOs, where the strategy has been to book profits. We have reduced our exposure further in equities and plan to keep it around the 5 per cent level. On the debt side, we have reduced the duration of the portfolio by cutting down long bonds.

Outlook and strategy

With the rally in G-secs and the flattening of the yield curve, our funds have reduced their exposure to very long maturity and have moved to shorter segments. This has resulted in reduced average maturity for our bond, dynamic and monthly income plans.

We intend to keep the maturity of these schemes lower in expectation of slight hardening of rates.

The expectations that the new government assuming power will kickstart spending along with good monsoons and robust growth in industrial production should keep the interest rates range-bound.

(Monthly market view from Sundaram Mutual Fund.)

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