Monday, November 8, 2010


Gilt/income mutual funds have two types of returns:
1. The interest return from the investment
2. Movement in the NAV, due to movement of the yield of the fund. If the yield goes up, the NAV falls, and if the yield goes down the NAV rises.

Current Yields

Currently the 10 year Gilt yields are 7.97%. They did go up to 8.15%. However, with the RBI announcement on 2nd November, of a 25 bps increase in repo and reverse repo rates, the 10 year bond yields actually fell. This is because the RBI clearly indicated that there is likely to be no more interest rate changes in the near future.

The average 10-year g-sec yield since January 2002 has been around 7.04%. Also, whenever yield crossed 8% during this period, it has not sustained that level for a long time. It did stay well over 8% for over four months in 2008, when there was a severe credit crisis.

Currently, only in 3 other countries - Pakistan (13.4%), Venezuela (13.05%) & Greece (8.82%), 10 yr G-sec trades at a yield higher than India. YTD, the yields in India has increased but decreased 295 bps in Indonesia, 232 bps in Philippines, 143 bps in South Korea, 121 bps in Thailand, 149 bps in Brazil and 130 bps in US.

Factors which are likely to cause fall in yields

1. Inflation
Inflation as measured by the Wholesale Price Index (WPI) peaked in April 2010. It is likely to moderate further because:
(a) RBIs policy of tightening liquidity.
(b) High base effect
(c) Positive impact of good monsoon.
(d) US/Euro region continue to show weak economic growth. China is showing signs of a slow down. This should result in commodities remaining stable on moving lower.

2. Fiscal Deficit
The fiscal deficit is expected to show an improving trend over the coming years, due to the following:
(a) High realizations from 3G and BWA auctions
(b) Increased prices of petrol and diesel (to be de-regulated over time). Prices of LPG and kerosene were also increased. Government finally showing signs of controlling oil subsidies burden.
(c) Tax collections have been above budget estimates
(d) Inflows to the Government due to disinvestments in PSUs

3. Increase in FII Limit
Government has recently raised the limit for FII investment in Government bonds to $ 10 bn from the earlier $ 5 bn, subject to certain maturity restrictions. The large rate differential between developed markets and India could attract offshore investors and potentially lead to increased flows in longer maturity government bonds.

4. Credit Off take unlikely to Surprise
Non-food credit growth is likely to move in the range of 20-22%. With RBI’s tightening measures over the past few quarters, credit off take is unlikely to be significant higher than market expectations.

HENCE, yields are likely to fall over medium term. Therefore, allocation to long-term bonds/ gilts is preferred and should give double digit annualized returns.