Recent performance of debt mutual funds and the outlook: 1) Short-term debt funds have outperformed longer-term funds due to volatility in the bond market and rising short-term interest rates. 2) Various domestic and global factors like high inflation, current account deficit, US tapering, and economic slowdown have kept bond yields elevated. 3) Going forward, short-term yields are expected to remain around 9.5-10% while 10-year bond yields could trade between 8.4-9.1%, depending on the election outcome and other macroeconomic developments.

1. RETAIL RESEARCH
Uncertainty over the direction of the interest rates in the domestic economy has kept the bond markets subdued over many
months. Due to heightened volatility in long term debt funds, short term debt mutual funds have been the investors’ choice
nowadays as they have seen delivering consistent returns. In other words, lower maturity debt mutual funds, say schemes
with an average maturity of one year and below, have posted relatively better returns compared to the debt categories with
higher average maturity. Elevated short term rates on account of liquidity pressures has majorly contributed to the
outperformance of the Short term debt mutual funds such as Short term Income, Floating rate Short and Long Term, Ultra
Short Term and Liquid funds categories during these periods.
Post July 2013, the many stringent policy measures taken by the RBI to curb the volatility in the forex market pushed the
banking system into cash crunching territory which led to elevating the short term rates. At the same time, unstable macro
indicators in the domestic as well as global fronts brought more volatility at the longer end that resulted in the long term
mutual funds such as Gilt Funds, Income Funds and Dynamic Income Funds to relatively underperform the short term debt
mutual funds (see the below table).
Performance of Debt Mutual Funds over the last two years:
Name of Category
Latest
Average
Maturity
(Years)
Trailing Returns (%)
Standard
Deviation
(Daily)
3
Months
Absolut
e
6
Months
Absolute
1 Year
CAGR
2 Years
CAGR
Falling
Interest Rate
Rising
Interest Rate
Falling
Interest
Rate
Mar '13 To
May '13
Absolute
May '13 To
Aug '13
Absolute
Aug '13 To
Jan '14
Absolute
Gilt Funds LT 8.77 1.92 2.41 2.08 5.44 5.82 -8.84 6.70 0.49
Income Funds 3.96 1.57 3.36 4.85 6.33 3.42 -4.23 5.52 0.25
Dynamic Income Funds 4.69 1.61 3.37 4.90 7.12 4.12 -5.29 6.51 0.31
Gilt Funds ST 3.65 1.76 3.79 5.56 7.26 3.40 -4.17 6.48 0.29
Short Term Income Funds 1.25 1.82 4.57 7.11 7.57 2.19 -1.17 5.13 0.12
Floating Rate LT 0.96 2.04 4.72 8.08 8.65 1.59 -0.04 5.07 0.10
Ultra Short Term Funds 0.36 2.00 4.65 8.66 8.65 1.57 0.93 4.46 0.06
Floating Rate ST 0.19 2.04 4.56 8.83 9.02 1.56 1.30 4.21 0.04
Liquid Funds 0.07 2.04 4.40 8.69 8.74 1.39 1.66 3.91 0.03
Note: NAV value as on March 08, 2014.
With elections just a few months away, we have attempted to estimate the movement of the yield curve till the period of the
announcement of the central election results. Post election, it is evident that the movement of the yields curve would be
based on the formation of government whether it is a stable Govt or an unstable coalition Govt.
Various factors such as persistently higher Inflation, high CAD, US fed tapering concerns, sharp depreciation in rupee value,
growth slowdown, high fiscal deficit, tightened policy stance by the RBI have kept the domestic debt market under check in
the last six month period.
Higher Inflation: Domestic economy has been struggling with persistent higher inflation with the CPI inflation numbers
remaining at an average of above double digit over the past two years due to highly volatile food and primary articles’ prices.
Hence, despite the headline WPI inflation falling to ~6.0% level in the recent months (more or less there in RBI’s comfort
zone), the RBI took hawkish stance by increasing its Repo rate to 8% to tame the inflation further in its January policy meet.
However the recent data shows the inflation in a falling trend. The CPI, for Jan 2014, eased to 8.79% YoY while the inflation as
measured by WPI cooled off to 5.05%.
RETAIL RESEARCH
March 13, 2014
Recent Performance of the Debt Mutual Funds and the Way Forward

2. RETAIL RESEARCH
Rate hike: Since September 2013, the RBI has hiked the repo rates three times to 8%. The rational for raising interest rate was
the elevated level of inflation even after excluding food and fuel components. The RBI’s decision reflected its shift towards CPI-
based policy-making as recommended by the Dr. Urjit Patel Committee. The RBI may pause on rate hike in the following
meetings since headline inflation trends have been encouraging although core inflation still remains at elevated levels.
High CAD: The current account deficit, the difference between inflow and outflow of forex, that touched an all-time high of
$88.2 billion in 2012-13, was the prime reason for the deterioration of the rupee value against the dollar in the last one year
period. The lifetime low of 68.85 (intra-day) by the rupee versus dollar on August 28 last year prompted the central bank to
announce a slew of measures to contain the volatility in the Forex market. The measures such as increasing the marginal
standing facility, allowing banks to borrow from LAF limiting to 1% of their NDTL, etc resulted in tightening the liquidity
situation in the banking system. This impacted domestic bond prices negatively. However that brought positive results on CAD
side as the latest data show that the CAD has stabilised for the October-December quarter narrowed to $4.2 billion, or 0.9% of
the gross domestic product (GDP), from $31.9 billion a year ago, or 6.5% on the back of turnaround in exports and decline in
gold imports. It is worth noting that between December 2012 and December 2013, exports rose from $74.3 billion to $79.8
billion while imports collapsed from $132.6 billion to $112.9 billion. Hence, sharply falling trade deficit along with steady
software earnings would likely result in much needed relief on the CAD in FY14 and hopefully in FY15.
US fed tapering concerns: An announcement by the US fed on tapering of the $85-billion per month quantitative easing (QE)
has impacted the domestic bond market negatively. The reversal in Fed policy on the back of recovery in the US macro
fundamentals to weigh on Emerging Market capital flows into countries like India. Post announcement of potential QE3
tapering in May 2013, the domestic markets saw significant debt sales by FIIs. Interestingly, post confirmation of tapering in
Dec 13, FII flows have been turned positive. The FII turned net buyers since December 2013, bought debt securities so far (till
10 Mar 2014) worth Rs. 45,000 crore. It is expected that Fed will continue with its tapering program and increase the size of
tapering gradually. The buying of debt by FIIs after announcement/continuation of tapering is more a reflection of their
expectation that India could stand apart in the emerging market turmoil and the FIIs could gain by appreciation in Rupee in
addition to handsome nominal yields.
Growth: India's economic growth remained stuck below 5% for the seventh consecutive quarter in Q3 as the GDP growth
numbers have been disappointing due to high inflation and waning investor confidence. GDP rose 4.7% in the three months
ended Dec 31 from a year earlier, compared with 4.8% in the previous quarter. The GDP had expanded 4.8% in the July-
September quarter and 4.4% in April-June. The government has forecasted the economy will expand 4.9% in the fiscal year
2014. The industrial production (IIP) growth contracted for a third straight month, at -0.6% YoY in December, from a revised -
1.3% YoY in November. Output growth contracted in the capital goods and consumer durables segments, highlighting
continued weakness in investment and consumer discretionary demand. The third quarter earnings season was a mixed bag
with marginal downgrades. Discretionary consumption has been slowing, which affected margins in the two wheeler and
commercial vehicle segments. Staples continued to see volume growth slowing. The banking sector too continued to see an
increase in NPAs and restructured loan pipeline.
Growth in the key infrastructure sector slowed to 1.6% in January from 8.3% in the same month a year ago due to poor output
of coal, petroleum refinery products and natural gas, adding to the concerns of industry. These numbers indicate that the
slowdown is entrenched in the economy and the prospects for a rebound in GDP are likely to depend on whether the elections
produce a stable coalition with a clear mandate. However, the declining fiscal deficit, stable Exchange Rate and reducing
Current Account Deficit, moderation in inflation, increasing exports are expected to boost the economy going forward.

3. RETAIL RESEARCH
Liquidity: The liquidity in the system remained on the tightened trajectory as the banks are seen in hurry to refinance the
maturing liabilities. This pushed the money market rates at higher. In the last six to seven months period, the money market
rates peaked to above 12% level, wherein the CD rates went upto 11.05% while the CP rates shot to 12.5%. Notwithstanding
the government spending and the RBI’s indication on conducting term repos in the following months, liquidity condition in the
banking situation is likely to remain tight amidst advance tax outflows, dividend payments to central govt. by the Public Sector
Units and Spectrum auction payments by the Telecom companies. However with a sharp cutback in non-plan and plan
expenditure to meet the fiscal deficit numbers and anemic demand for growth, the liquidity situation in March this year may
be better than the past few years.
Movement in the yield curve: Movement of the 10 year G sec benchmark yields saw an upward trend in the last six months
period on the back of weak macroeconomic numbers. The benchmark yields went up to 9.23% on Aug 19, 2013 due to Central
bank’s measures to contain the rupee volatility. Currently, the yields of the 10 year benchmark ‘G Sec 8.83% GS 2023’ settled
at 8.81% (as of 10 Mar 2014). Money market rates also peaked to above 12% level in the last six to seven months period,
wherein the CD rates went upto 11.05% while the CP rates shot to 12.5%. At present the CD rates hovered close to 9% while
the CP rates placed at 10% (as of 10 Mar 2014). G sec Bond Yields tend to trend lower in coming months considering the
overall better macro situation while the short term rates are likely to remain elevated.
Considering above facts, going forward the period till the election results announced, we feel that the short term yields are
expected to hover close to 9.5-10% level while the 10 year G sec benchmark yields could trade in the 8.40-9.10% level. While
better Govt financial situation and expectation of stable Govt at the centre could pull the rates down, further increase in the
size of tapering by FOMC, sharp withdrawal of FII investments from domestic market, likelihood of a unstable coalition
Government, increased geo political tensions, weakness in the rupee value, unexpected hike in the policy rate by the RBI,
sticky core inflation, higher bond supply, etc can worsen the situation and lead to higher interest rates.
What happened during 2009 elections…
Although the macro and global factors were different at that point in time, (with the world just coming out of the global
slowdown triggered by the lehman crisis) and the levels of interest rates too were low (5-7%), we observe that interest rates
began to rise post announcement of election dates and started to fall once the elections began (on hope of a stable Govt
formation post the elections). They again rose a bit till the elections ended and dipped once the results came out and showed

4. RETAIL RESEARCH
that the UPA had achieved a comfortable majority. After the PM was sworn in the interest rates began to rise on expectations
of pick up in economic growth and credit growth.
To conclude,
Conservative investors with short term investment horizon can consider investing Liquid, Ultra Short term, Floating Rate and
Short Term Income funds. One year plus Fixed Maturity Plans (growth option) are preferred tax efficient investment option for
low to medium risk profile investors to lock in for a year.
Low to Medium risk profile investors who want to stay invested for more than two years can consider investing in Short term
and Medium term Income funds which are maintaining modified duration of less than 2 years.
Medium to High risk profile investors can consider investing in best performing Income, Dynamic Income and Gilt Long Term
funds and hold for at least two years.
Top performing schemes from debt oriented categories:
Scheme Name
NAV
(Rs)
Fund Size (Crs.
Rs)
1 Year
Return
2 Year
Return
3 Year
Return
Standard
Deviation
Liquid Funds
Morgan Stanley Liquid Fund (G) 1250.92 398 9.42 9.44 - 0.03
Union KBC Liquid Fund (G) 1274.76 2041 9.31 9.41 - 0.03
Ultra Short Term Funds
JM Money Manager Fund - Super Plan (G) 18.13 521 9.09 9.50 9.62 0.04
SBI Magnum Income FRP - Savings Plus Bond G 19.75 489 9.15 9.43 9.52 0.03
Short Term Income Funds
Sundaram Select Debt - STAP (G) 21.66 850 9.07 9.98 11.25 0.13
Birla Sun Life Short Term Fund (G) 46.57 4848 8.36 9.25 9.53 0.12
Income Funds
Birla Sun Life Medium Term Plan (G) 15.04 2210 10.38 10.65 10.35 0.17
Templeton India Income Opportunities Fund 14.24 3872 8.55 9.31 9.46 0.18
Gilt Funds
IDFC G Sec Fund - Invst Plan - A (G) 23.78 558 3.67 8.48 9.41 0.51
Tata Gilt Mid Term Fund (G) 12.96 44 6.00 7.97 8.17 0.41
Falling Domestic Current Account Deficit: Trend in 10 Year G sec Benchmark yields (%):

5. RETAIL RESEARCH
Changes in the Money market Rates (%):
Liquidity Provided by RBI (Rupees in Billion):
Analyst: Dhuraivel Gunasekaran (Email: Dhuraivel.gunasekaran@hdfcsec.com) Source: NAVIndia, ACEMF, RBI & AMC Sites
RETAIL RESEARCH Fax: (022) 3075 3435
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www.hdfcsec.com
Disclaimer: Mutual Funds investments are subject to risk. Past performance is no guarantee for future performance. This document has been prepared by HDFC Securities Limited and is meant for sole use by the recipient and not for
circulation. This document is not to be reported or copied or made available to others. It should not be considered to be taken as an offer to sell or a solicitation to buy any security. The information contained herein is from sources
believed reliable. We do not represent that it is accurate or complete and it should not be relied upon as such. We may have from time to time positions or options on, and buy and sell securities referred to herein. We may from time to
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Yield curve movement in G secs with varing maturities:
Average Maturity in Long Term Debt MF categories (years):