 "Funds cut exposure to state debt")
Securities issued by state governments are losing their popularity among debt fund managers at domestic mutual funds. The narrowing spread between state development loans (SDLs) and central government securities (G-Secs) has made fund managers pare down their holdings in the former. The spread, which was as high as 80 basis points at one point, has come down to 40 basis points, said fund managers. With interest rates expected to come down in the future, the appeal for SDLs is likely to fall further, they added.
“Our current exposure in these securities is at a low of about five per cent. We had higher exposure but sold off into the rally that happened in the last two weeks,” said Lakshmi Iyer, head-fixed income, Kotak Mutual Fund.
In the debt segment, price and yield share an inverse relation. Spreads between G-Secs and SDLs had widened on the back of falling G-Sec yields. As the sentiment turned bullish on G-Secs, their prices started to move up. However, after the Reserve Bank of India (RBI)’s policy review, which did not lead to any rate cuts, the sentiment on the government securities turned bearish.
“Post the policy announcement, the sentiment turned bearish and gilt yields started to move up, but SDLs remained at the same levels narrowing the spread between the two,” said Killol Pandya, senior fund manager-debt, LIC Nomura Mutual Fund.
Yields on SDLs have been unable to move up due to a fall in trader-led demand for these instruments and increase in investor-driven demand, unlike in the case of G-secs. This segment has not seen too many new issuances leading to supply-side constraints.
In January this year, spread was about 80 basis points with the 10-year yield on G-secs trading at eight per cent, while those on SDLs were at 8.80 per cent. Since then, the lowest the spreads have touched is 40 basis points with the 10-year G-sec yields at 7.20 per cent, while those of the state loans at 7.60 per cent.
The credit-risk on both these securities is the same as both have sovereign backing. However, SDLs are less liquid than G-secs, thereby, commanding a higher yield. Based on the liquidity factor, G-secs are any day preferred over SDLs, fund managers said.
But data on the investment pattern of debt schemes tells a different story. According to data from Value Research, close to 250 funds have exposure to SDLs. Gilt funds, which invest mainly in G-secs, have the highest exposure to these securities.
Debt fund managers of some of these funds are not looking to reduce this exposure at current levels. They are waiting for spread to fall below the 20-25 basis points.
“Around September-October last year, the spread was between 75-80 basis points. Since then, we have seen almost sustained compression in the spreads and it has come down to 30-40 basis points now,” said Kumaresh Ramakrishnan, head-fixed income at Deutsche Asset Management. DWS Gilt fund has an exposure of about 84.8 per cent in state loans, as of May 2013.
“We are not looking at paring down our exposure to SDLs at this point. If SDL spreads over G-Secs compress further from here, we would then re-evaluate our strategy on SDLs,” added Ramakrishnan.
Historically, average spreads between the state and government securities have been 55 basis points. Since SDLs currently are below these averages, fund managers are considering a re-look at their strategies.
While they agree that there is some more room for SDLs to continue to perform, they do not expect to see any sharp gains from this point.
“Volumes on state loans have been low for some time now. Issuers are not looking at launching any new issues until the spreads expand. They are unwilling to sell in secondary market at lower levels. Once the primary market supply comes in, these papers could start commanding better yields widening the spread,” said Dwijendra Srivastava, head-fixed income, Sundaram Mutual.
Auctions for new issuances by the states are held on every alternate Tuesday. At present, state loan papers of states like Gujarat, Maharashtra, Karnataka and Tamil Nadu are popular among fund managers.