Impact of RBI’s Monetary Policy Committee (MPC) announcements on 31st August 2020 on Mutual Funds.
Statements by RBI
Statement by RBI on 6 th August 2020
The Monetary Policy Committee is conscious that its primary mandate is to achieve the medium-term target for CPI inflation of 4 per cent within a band of +/- 2 per cent. It also recognises that the headline CPI prints of April-May 2020 require more clarity. At the current juncture, the inflation objective itself is further obscured by (a) the spike in food prices because of floods in eastern India and ongoing lockdown related disruptions; and (b) cost-push pressures in the form of high taxes on petroleum products, hikes in telecom charges, rising raw material costs reflected in upward revisions in steel prices and rise in gold prices on safe haven demand. Given the uncertainty surrounding the inflation outlook and taking into consideration the extremely weak state of the economy amid an unprecedented shock from the ongoing pandemic, it is prudent to pause and remain watchful of incoming data as to how the outlook unravels.
Statement by RBI on 31 st August 2020
What changed in 25 days?
From the previous MPC minutes, the latest statement from RBI said that CPI inflation is moderating, and Rupee appreciation can contain inflationary pressures.
Actions Taken by RBI
The Reserve Bank of India then announced a series of measures to foster orderly market conditions, after hardening of yields (10 Year benchmark yields up by 30 bps in August) post MPC and MPC minutes.
• The limit for held to maturity (HTM) portfolio of banks hiked to 22% from 19.5% for securities acquired from Sep 2020 to Mar 2021
• RBI to conduct additional twist operation for INR 200 bn in September
• RBI to conduct term repo operations for INR 1 trillion in September
• The RBI stands ready to conduct market operations as required through a variety of
instruments so as to ensure orderly market functioning
HTM Limit hiked from 19.5% to 22%
The bonds held in HTM (Held to Maturity) portfolio of banks are not subject to mark to market risk, hence this move might encourage banks to buy G-Secs in their HTM book. This could create an additional space of INR 3.5 trillion (2.5% of Net Demand and Time Liabilities). These purchases have to be done from September 01, 2020 to March 21, 2021 and the relaxation in the HTM limit will be reviewed thereafter. We expect banks to largely use this additional space for buying large SLR supply in H2:2020-2021, especially with higher issuance of SDL’s expected by market.
Twist Operation (Special Open Market Operation)
The systemic INR liquidity has been abundantly surplus, and hence RBI has been mostly conducting the twist operation (buying longer end and selling short end securities) as it is liquidity neutral. In addition to the INR 200 billion special OMO already announced on August 25th, additional special OMO for INR 100 billion each will be conducted on Sept 10th and Sept 17th. We expect RBI to continue this unconventional Operation twist mechanism for another couple of months, totaling INR 1.5 trillion to 2 trillion.
Term Repo Operation for INR 1 trillion
RBI will conduct term repos for INR 1 trillion at the policy repo rate (floating rate) in mid-September. RBI has also provided an option to banks who had borrowed funds under LTRO in Feb-March at a fixed rate of 5.15% (policy repo rate in Feb-March) to reverse these long term repos and avail funds at the current repo rate of 4%, thereby reducing their cost of financing.
Ensure smooth market functioning
The RBI has reiterated its commitment to ensure orderly market functioning. This suggests RBIs discomfort with significant rise in yields and market might continue to expect some RBI measures if yields were to rise again towards August end levels.
Market outlook
Impact on our Funds
With MPC maintaining status quo on policy rates, hawkish comments from few members in the MPC minutes, fears of CPI staying above 6% in the near term and delay in RBIs response, yields moved up sharply in month of August. After the large auction devolvement last Friday, market was expecting some follow up measures from RBI and RBI lived up fully to it. We expect 10 Year yield to drop below 6% and test 5.90%-5.95%, which was the upper end of range before release of MPC minutes.
Further, with RBI reiterating its commitment to market, we expect more ammunition from RBI in coming months (OT + OMO = INR 3 trillion). This would cool off yields, especially belly of curve (10- 13yr) as the yield curve is very steepened. Also, with term repo announcement, RBI has effectively capped up-move in short term yield curve.
Hence, we expect overall yield curve to shift downwards. Going ahead, we believe headline inflation will move within the RBI band by December, thereby creating space for easing and supporting economy. Therefore, we stay bullish on the debt market and have positioned our funds accordingly.
Tata Dynamic Bond Fund (An open-ended dynamic debt scheme investing across duration)
We had increased exposure to G-secs and the Modified Duration has moved up from ~3.35 years in April end 2020 to ~6.50 years in July end 2020. The increase had been done mostly in the belly of the curve with a view that this segment could rally going ahead. The month of August saw MTM impact as MPC did not cut rates and also MPC minutes also raised alarm on headline inflation. The 10 Year benchmark yield hardened by more than 30 bps, and pressure on short term yield curve and medium-term yield curve was very evident. With RBI starting its Operation twist and expected to continue using its arsenal of measures (both conventional and un-conventional), we believe the overall yield curve will shift downwards. With this view, we continue to maintain our stance and portfolio positioning – duration above 6 and overweight on belly of curve.
Tata Gilt Securities Fund (An open-ended Debt scheme investing predominantly in government
securities across maturities)
We have been running an average maturity of more than 10 years in the fund. All the measures taken by RBI is to support the government borrowing program and the banks who are major buyers of these securities. Given our view of 10 Year G sec trading in the band of 5.65 to 5.90 levels, we expect spread compression in longer dated papers, our portfolio should be skewed towards the longer end of the yield curve. We expect banks to buy the longer end of the G securities for the HTM Category as accrual is higher in this segment. Nationalized banks due to their risk averse nature and low capital base will be major buyers in government securities. The upside of yields is capped due to above mentioned measures. We will be running a higher average maturity to take advantage of this situation.
Tata Treasury Advantage Fund (An open-ended low duration debt scheme investing in instruments such that the Macaulay Duration of portfolio is between 6 months and 12 months)
The scheme Has 1 Segregated Portfolio
We had positioned our portfolio closer to the upper end of regulatory duration band given our view
on interest rates, however, after the MPC policy, we had reduced the duration at margin and managed to avoid part of MTM impact in August. With RBI reiterating its commitment towards the smooth functioning of markets and using liquidity as one of tools, we believe that overall yields will drift downwards and hence portfolio duration will be closer to upper end of regulatory band. We continue to maintain high quality safe portfolio and aim to generate returns from safe accruals along with possible capital gains from fall in interest rates.
Tata Short Term Bond Fund (An open-ended short-term debt scheme investing in instruments such that the Macaulay duration of portfolio is between 1 year and 3 years)
We have been running average maturity of above 3 years in this fund from March 2020 onwards as we expect RBI to continue maintaining an accommodative monetary policy and cut benchmark repo and reverse repo rates in the current financial year. The AAA PSU bond to G sec spread has reduced to 15 to 30 basis points, which has made the spread trade unattractive. Corporate bonds also have illiquidity risks compared with G sec.
We are running average maturity of 3.4 years in this fund for the month of August. We expect the 10-year G sec rates trading in the band of 5.65 to 5.90 levels in the coming months due to the mentioned measures. RBI has also given comfort to the market on CPI inflation and maintaining orderly conditions in the market. All the measures like OMO, Operation Twist, increase in HTM limits are supporting the Government bond yield curve. Given higher liquidity and attractive carry in the 3 to 5 years G sec, we have increased our G sec exposure from 22 percent to 34 percent in the month of August. We plan to maintain the average maturity of the fund at the 3-year levels.
Tata Money Market Fund (An open-ended Debt scheme investing in Money Market Instruments)
The scheme has a maturity cap of 12 months and can invest only in Money Market instruments viz.
CP/CD and T-Bills etc. The fund is predominantly invested in securities that are maturing in Jan-March 2020. The fund has been progressively reducing the average maturity of its portfolio. The scheme will continue to invest in high quality assets and endeavor to maintain current allocation.
Easy Liquidity environment along with accommodative monetary policy bode well for the portfolio plus the FM would take up some trading calls. The fund had captured Spread trade by increasing
sovereign allocation (G-sec/T-Bills) contributing to the fund performance. The fund was also able to
actively deploy investments appropriately helping performance. The fund should perform due to
attractive spread available in the short to medium term. Fund is positioned to take advantage of fall
in yields due to easy liquidity environment driven by RBI measures.
Tata Banking and PSU Debt Fund (An open-ended debt scheme predominantly investing in debt
instruments of Banks, Public Sector Undertakings, Public Financial Institutions and Municipal Bonds.)
The scheme has invested 100% of its assets in Banking/PSU debt and G-sec. Given current compression in corporate bond spread over sovereign bonds, Fund has increased allocation to the latter recently. The fund has been running Macaulay duration around 3.0- 3.3 years and is currently well positioned to capture the attractive spreads available in the Short to Medium term. The fund is positioned to take advantage of the fall in yields due to rate cuts and unconventional measures of RBI. The positive MTM impact due to falling yields and spread compression in the past year has been a key return driver for the fund. Near term performance, however, was negatively impacted on account of the MPC minutes.
While the yields of PSU instruments have been falling over time, AT1 bond yields fell to a greater extent in past two and a half months. The Fund was able to capture the fall in yields on account of the same.
Investors kindly note that investment /portfolio strategy of the schemes are subject to change without prior notice. There are no assured or guaranteed returns under any of the schemes of Tata Mutual Fund.
Tata Dynamic Bond Fund
Tata Gilt Securities Fund
Tata Treasury Advantage Fund
Tata Short Term Bond Fund
Tata Money Market Fund
Tata Banking & PSU Debt Fund
Disclaimer: The views expressed are of Tata Asset Management Ltd. and are in no way trying to predict the markets or to time them. The views expressed are for information purpose only and do not construe to be any investment, legal or taxation advice. Any action taken by you on the basis of the information contained herein is your responsibility alone and Tata Asset Management will not be liable in any manner for the consequences of such action taken by you. Please consult your
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portfolios of Tata Mutual Fund.
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