Time to play duration game

For the past few months, we have been emphatically suggesting to build exposure to long duration. While RBI preferred to stay focused on inflation over growth side in its last monetary policy, we at Pentagraph, still feel confident about the rate cut in coming quarters and suggest building an exposure to duration strategy funds along with accrual strategy funds.

We have taken the latest data on Govt Borrowing.

Government Borrowing Programme (Rs.   Cr.)
Budgeted   G-Sec Gross Borrowings for 2011-12 569616
Budgeted   G-Sec Net Borrowings for 2011-12 479000
Budgeted   Redemptions 90616
G-Sec   Gross Borrowings till Date 422000
G-Sec   Gross Borrowing Completed (%) 74.09%
Maturities   till date 85615
Net   G-Sec Borrowings till Date 336385
364 Day   T-Bill Gross Borrowings till date 80000
OMO   Purchases till date 54573
SDL   Auction till date 97490

Source: http://www.stcipd.com

 It indicates that Government Bonds are likely to outperform in coming year.Our reasons for expecting this are as follow

  1. Most of the Budgeted G- Sec borrowing is completed .
  2. The RBI is also likely to conduct more OMO bond purchases worth Rs. 60,000 crore to 1,00,000 crore in the second-half of the year to support systemic liquidity and growth.
  3. State Development loans (SDL) which are issued by the state governments directly and count as SLR securities are quoting at 9 – 9.05% levels on annualized yield basis. As against this, 10 year AAA corporate bonds like REC and PFC are quoting at approximately 8.95% levels. These levels are not likely to sustain for a long time and bound to see correction.
  4. Most Important , Government is guiding to bring fiscal Deficit down by adopting different strategies & reform and hinting RBI to lower the rates subject to their inflation expectation.

Therefore , The debt fund running overweight on Government Bond exposures will do better if governement bonds yield fall. The duration funds like income / dynamic bond funds would be better choice to grab this opportunity keeping one year horizon .