November saw a sharp rebound in India’s financial markets as key headwinds suddenly became tailwinds.Summary

• November saw a strong rebound in India’s financial markets, led by a sharp fall in crude prices, temporary suspension of the trade dispute between the US and China, dovish comments by the US Federal Reserve (the Fed), favourable opinion polls on ongoing state elections, aggressive liquidity injection by the RBI and favourable inflation readings despite supply side pressures.
• With almost everything going right, Foreign Portfolio Investment (FPI) inflows drove a 4.72% gain in equity (Nifty) and a 1.86% appreciation in bonds (CRISIL Composite Index) in local currency terms. The Indian rupee posted a 6.10% gain.
• Extreme volatility has thwarted potential opportunities in government securities (G-Secs) that emerged with the recent selling pressure. Despite this rapidly shifting environment, corporate bond spreads remain oversold and managers believe it is appropriate to further increase exposure here from already high levels.

Market update

November saw a sharp rebound as key headwinds suddenly became tailwinds:

• Crude prices dropped sharply on a favorable supply/demand outlook and a 180-day suspension of an embargo on oil exports from Iran. The crude plunge alleviated pressure on India’s balance of payments, eased short-term liquidity concerns and supply side inflation pressures
• The US-China trade headlines have been a big disruptor for markets. A temporary suspension of hostilities to renegotiate trade disputes mitigated concerns of a China slowdown and its impact on currency markets.

The juxtaposition of headwinds was further supported by:

• The Fed’s Chairman Jerome Powell’s comments that interest rates are “just below neutral”, signaling a dovish turn for the Fed rate hikes in 2019 and beyond
• India is currently going through elections in five of its states, three of which; Chhattisgarh, Madhya Pradesh and Rajasthan are governed by the incumbent, centrist Bharatiya Janata Party (BJP). Opinion polls suggest a 2-1 victory in favour of BJP, which has calmed investor anxieties within India ahead of next May’s general elections
• The RBI aggressively added liquidity to limit pressures faced by non-banking financial services companies (NBFCs) as they account for 18% of the overall credit disbursement in the country
• Consumer Price Index (CPI) data surprised, as October retail inflation was 3.31%, a 13-month low, versus 3.77% in September. In its subsequent policy meeting on 5 December, the Monetary Policy Committee acknowledged the benign forces and revised down CPI projections for 2HFY19 to 2.7-3.2%, it was 3.9-4.5%, and for 1HFY20 to 3.8-4.2%, which was previously 4.8%.

A key outcome

The confluence of events in November sparked a return of foreign portfolio investors, with net buy trades worth US$780 million and US$180 million in debt and equity markets respectively.

Performance

On a point-to-point basis, the benchmark 5-year yield on government bonds fell by 36bps from 7.83% to 7.47%. Conversely, the spread on 5-year AAA and AA corporate bonds widened by 12 bps (86 bps to 98bps) and 22 bps (148 bps to 170bps) respectively. This capped the gains in NAV at 0.89% in Indian rupee terms. A 6.10% Indian rupee appreciation versus the US dollar yielded a solid NAV gain of 7.04% in US dollar terms. Year-to-date, the Fund’s NAV is 3.07% in Indian rupee terms and -5.61% in US dollar term when adjusted for the 8.42% Indian rupee depreciation.

Strategy

Some volatility is necessary and aids performance, extreme volatility does not. Summarizing thoughts on factors that drove relative under-performance of the Fund in November; the yield curve on G-secs was inverted for maturity between 5-10 years for the past three months. This backdrop and macro headwinds precluded the Fund Managers from extending portfolio duration. The strategy was apt as the yield curve returned to positive territory in November with higher absolute basis points softening in 3-5 years G-Secs (36 bps). Unfortunately, the overall curve dropped too suddenly and too sharply; 10-year yield dropped down 25 bps, resulting in a larger price appreciation in longer maturity G-secs. The Fund Managers continue to monitor the yield curve closely for meaningful opportunities.

The Fund is aggressively positioned with higher exposure to corporate bonds (60% of AUM). At the start of the month, the spread on 5-year AAA and AA bonds at 86 bps and 148 bps respectively was at the higher end of long-term range of 50-150 bps and 100-180 bps respectively. Despite a strong liquidity injection by the RBI and a strong growth outlook, spreads widened further in November to 98 bps and 170 bps respectively. The Fund is continuing its credit research, and believes it is appropriate to further increase this exposure when it finds opportunities.