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Debt index funds with ‘AAA’ PSU bonds, SDLs score high on safety

Mumbai: Debt funds based on assessing credit risks were in great demand a couple of years ago. And the winning formula was the riskier, the better. But that was then. Life has come a full circle in that segment of the market.

Debt index funds are now gaining currency because of their portfolio of AAA-rated PSU bonds and state bonds, called state development loans (SDL) in market parlance.

After the series of negative events in the fixed income space, conservative investors are keen to play it safe and are comfortable with PSU bonds or SDLs with no fund manager intervention.

“Passive index funds give you transparency, liquidity and visibility of returns with a low cost,” said Niranjan Avasthi, head-products, Edelweiss Mutual Fund. He points out that such funds are gaining traction among investors with assets under management moving up to ₹47,000 crore.

Distributors point out that investors save on expenses in passive debt funds, which increases their overall returns.

For example, in the medium-term debt fund category, the expense ratio in direct plans for schemes varies between 39-143 basis points. As compared to this, in passive debt funds it is 15-20 basis points.

Secondly, there is the visibility of returns in passive debt funds as they have a maturity date and on maturity, the investor is paid back the proceeds. In open-ended schemes, the returns earned could change and vary depending on the interest rate environment. Also, an investor gets back money only when he puts in a redemption request. These index funds also give investors liquidity with the ability to buy or sell as compared to fixed maturity plans (FMP) where they can only transact on the stock exchange.

Some financial planners believe investors can build a ladder around these products to give them both liquidity and returns.

MF

“Conservative fixed-income investors can have a mix of passive debt schemes maturing over a 3-10 year time frame across different fund houses to persify and optimise returns,” said Nirav Karkera, head of research, Fisdom. Karkera recommends investors adopt this approach to build a ladder.

If investors hold for three years and beyond they get indexation benefits which will significantly reduce their capital gains tax outgo.

For a 3-3.5 year horizon, Karkera recommends, the Bharat Bond Fund of Funds (FOF) maturing in April 2025.

For a five-year horizon, he suggests Aditya Birla Sun Life Nifty SDL Plus PSU Bond September 2026 60:40 Index Fund, which has 60% in PSU bonds and, for six years, IDFC Gilt 2027 Index Fund.

Karkera recommends the Bharat Bond FOF maturing in April 2030 and April 2031 for a 9-10 year time frame. Using these products investors can earn a return in the range of 5.5- 6.78%.

Asian stocks | Asian stocks steady as calm returns but jitters keep dollar firm

HONG KONG: Asian shares found some calm on Thursday following this week’s heavy China-driven losses although the

dollar

sat at a more than one-year high against major peers, upheld by lingering safe-haven demand and expectations for tighter U.S. monetary policy.

MSCI’s broadest index of Asia-Pacific shares outside Japan dropped 0.06%, while the Nikkei lost 0.36% a day after Japan’s ruling party chose softly spoken consensus-builder Fumio Kishida as its new leader and the country’s new prime minister.

Worries about economic growth in China due to a worsening power crunch combined with fears of a global slowdown, hitting Asian shares on Wednesday.

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However, the dollar index – which measures the U.S. currency against six major currencies – hit its strongest level in nearly 18 months against the yen and in 14 months against the euro. It held these gains in Asian hours, and was last at 94.314.

“(The dollar) is breaking key levels and there was no real resistance to the break so that tells you there was real underlying strength to that,” said Chris Weston, head of research at Melbourne brokerage Pepperstone.

“Sometimes, it can become somewhat of a magical currency,” he said, pointing to the fact that it was supported by both global investors seeking safety and the Fed inching closer to reducing its massive asset purchases. In addition, “the ongoing U.S. debt ceiling stand-off could briefly amplify financial market jitters and support the USD in the short-term,” said analysts at CBA in a note.

U.S. lawmakers continue to wrangle over funding the government but face a Friday deadline to prevent a shutdown approached, something that also capped gains in U.S. equities overnight.

In Asian equity markets, Hong Kong stocks fell 1% but these were largely balanced by a 1.1% rise in Australia.

Chinese blue chips gained 0.5% after data published early on Thursday showed China’s services sector returned to expansion in September after COVID-19 outbreaks receded. However, but factory activity unexpectedly shrank as high raw material prices and power cuts continued to pressure manufacturers.

“It is likely that the power crunch in China will persist until end-2021, as the local governments are under pressure to fulfil emission reduction goals for this year,” said Chaoping Zhu, Global Market Strategist, J.P. Morgan Asset Management in emailed comments.

“Investors might remain cautious on China’s corporate earnings (in the fourth quarter). Meanwhile, the volatile global market is expected to further weigh on investor sentiment in the near term.”

The other main drag on investor sentiment in greater China was embattled developer China Evergrande, whose shares swung back and forth, and were last down 2.2%

The company was due to pay interest on a dollar bond on Wednesday, but Reuters reported that some offshore bondholders had not been paid interest by the end of the Asian day.

Overnight, the Dow Jones Industrial Average and the S&P 500 both posted small gains but the Nasdaq Composite dropped 0.24%.

Oil prices edged lower, extending losses after official figures showed an unexpected rise in U.S inventories.

Brent crude was down 0.14% to 78.53 a barrel, U.S. crude dipped 0.03% to $74.81.

Spot gold traded at $1,731.99 per ounce, near a seven-week low, constrained by a strong dollar.

Global Trade And The Yuan

Investors continue to try to wrap their heads around what China did last week with its currency. It seems like many are putting much emphasis on the move to weaken the yuan to regaining export competitiveness. We think this exaggerates the linkages between currency movement and exports.

As my colleagues Dr. Win Thin and Ilan Solot have noted, Asian exports have been weak, even for countries that have experienced currency depreciation are not reporting export growth. Most notably, Japan, which has seen the yen decline nearly 17.7% over the past year, reported a 4.4% decline in exports quarter-over quarter today as part of the Q2 GDP data. It was the biggest quarterly decline in five years.

The South Korean won has lost about one seventh of its value against the dollar over the past 12 months. In July, Korean exports were 3.3% lower than a year ago and have been consistently falling since last November (with last December the sole exception). The Taiwanese dollar has declined by about 7.5% over the past year. Its exports have fallen 11.9% over the past year. They have fallen since last December (January is the sole exception).

The Hong Kong dollar is formally tied to the US dollar. This has meant appreciation of the HKD against most currencies, yet its exports have until very recently fared better than most. Exports were firm in Q1, but fell in two of the three months in Q2, with a 3.1% fall on a year-over-year basis in June. That was the third contraction in four months. The monthly average this year has been +0.5%.

A look at the three largest eurozone members show that the 17% decline over the past 12-months has not been an unalloyed blessing. Germany’s June exports were off 1.0% from a year ago. Over the past 12 months, exports have averaged a 0.7% gain. Over the past six months, 0.5% (the same as Hong Kong). Italy’s exports have contracted on a year-over-year basis each month this year. In June, they were 3.6% below year ago levels. They have not been this week since 2009.

France is the exception. It exports have been robust. There has not been a negative year-over-year print since last October. The most recent reading was for June. Exports were up 8.8%, which is the strongest year-over-year performance since May 2012.

The Federal Reserve’s broad trade-weighted measure of the dollar made new cyclical highs in July. US exports have fallen each month on a year-over-year basis this year. They were 3.6% lower than a year ago in June. The monthly fall this year has been 2.9%, and -0.2% over the past 12-months.

While the dollar’s appreciation has been acknowledged as a headwind on US exports, something else is at work. Domestic demand in Japan, Europe and many emerging markets is weak. Moreover, what growth is taking place is generating less trade. Since the Great Financial Crisis, trade flows remains weak, as this Great Graphic from McKinsey Global Institute shows, especially relative to growth.

Weak Trade Flow

The World Trade Monitor reports that the volume of trade itself has been weakening. It fell in four of the first five months of the year. In May, it was up 1.2% from a year ago, which is slower than world growth. The longer-term average is closer to 7%.

The IMF’s research concurs. In the 1990s, a 1% rise in global growth helped lift trade by 2.5%. Since 2013, the same increase in world GDP lifts trade by 0.7%.

China’s exports were traditionally import intensive. In the mid-1990s, nearly 2/3 of the value of China’s exports were derived from imported parts and materials. This may have been cut almost in half in recent years. A small depreciation of the yuan on a trade-weighted basis, paring a fraction of its earlier gains, is unlikely to boost exports.

China is not nearly as reliant on exports as many observers suggest. Net exports have been a drag of about 3% a year on average over the past decade. China transitioned from export-led growth to the investment-cum-debt growth.

Many observers would have us believe that Chinese policy makers, frustrated with the drop in the stock market and the weakening economy, have opted to move backwards to mercantilism. Instead, we suggest that last week’s measures were about going forward: Going forward with the liberalization of the exchange-rate mechanism that both the IMF and the US have been advocating. Chinese officials are committed to the transition to more consumption and service-oriented growth. A slightly rich currency is conducive for this process.

One of this year’s policy goals was to have the yuan be included in the next rendition of the SDR basket. We think that the move on the exchange-rate mechanism, especially if implemented as officials suggest, makes it more likely — not less — that the yuan will be included. The IMF’s recently issued staff report recognized the hard work China has already done but calls for it to do more. It was running out of time before the IMF’s formal SDR decision and, before the Fed’s lift-off, which would only complicate such a move later.

Original Post

Asian Currencies Under Heavy Pressure, Euro Weakens

Market watchers are trying to catch their breath after all of the recent turmoil and take stock (pun intended) of the current situation. The short version: it’s confusing, and it’s volatile.

In China, the government has spent over $200 billion in market interventions, and devalued the currency, but Shanghai’s main stock market is still down 40% from its June peak. CNN is reporting that China’s 2015 Q2 growth report came in at 7%, but that the government target was – wait! – 7%. No one really believes Chinese government growth predictions anymore, and the country’s electrical production, manufacturing indexes, and rail freight volumes are all dropping sharply. It’s getting hard for China to hide its steep economic slowdown.

China is the world’s second largest economy, so this is naturally having serious effects pretty much everywhere. US stock markets experienced a massive drop in the wake of China’s market crash, and have been volatile ever since, with big gains followed by steep losses. The general price trend is downwards, and it’s the behavior expected in the lead-up to another, more serious, crash. Investors, be wary.

In forex markets, Asian currencies are under heavy pressure. The Malaysian, Indonesian, and Vietnamese currencies have all dropped sharply or been devalued under the influence of Chinese exposure, and South Korea’s won is trading at 5 year lows against the dollar. With dropping demand in China, commodity-linked currencies are especially hard hit. The Canadian dollar has fallen sharply against the US dollar, with the USD/CAD at 1.3286. The Australian dollar also has fallen, and the AUD/USD is trading at 0.6972.

Both the Aussie and the loonie have tracked the price of oil, which, despite a recent surge, is still down about 50% from last year’s high prices. Brent crude is trading for $48.17 per barrel, and West Texas for $44.80 per barrel. Watch that US price closely – the US markets are reopening after a holiday weekend, so it’s likely to be more volatile than usual today.

Finally, in Europe, Greece is heading for spot elections which will likely be seen as (another) referendum on the bailout terms and the euro. Alexis Tsipras is betting that his personal popularity will get him back into office, but right now his Syriza is fragmenting and running neck and neck with opposition. The never-ending drama in Greece may be contributing to the euro’s weak performance, at just 1.1180 to the dollar.

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Will Turkish Lira Keep Falling?

An emerging market economic crisis is nothing new but Turkey is the world’s 17th largest economy and the dramatic drop in the currency raises bigger questions. The lira fell another 11% in early trading Monday to 7.15. CFTC positioning data showed more money going into US dollar longs. USD/JPY held support at the confluence of the 55-DAY and WEEK moving average, while EUR/USD held above its 200-week moving average. The yen remains the strongest of the week and the month ahead of the US dollar, while the franc holds firm. Macro data return this week with UK jobs (Tues), CPI (Wed), US retail sales (Wed), US industrial production (Thurs) and UK retail sales (Fri).

USD

Crisis and collapse are words that are too-often used in financial markets and economics but the current situation in Turkey is worth of both. The Turkish lira is down 50% this year and fell by as much as 16% on Friday before an 11% drop early Monday.

The country’s large current account deficit (over 5% of GDP) and the inability of the central bank to control 16% inflation has exacerbated capital flight. It’s a situation that has many historical parallels and often leads to a run on banks and terrible economic outcomes.

Erdogan on the weekend continued to plea with people not to take money out of the country but that kind of begging only underscores the lack of options. He also hinted at Plan B and Plan C, which sounded like a mixture between capital controls and tighter monetary policy. The problem with a hint like that is that it ensures a stampede to the exits before the banks lock down.

An implosion of the Turkish economy alone may not pose a risk to the global economy but could intensify pressure on emerging market indices. With GDP of about $850B, it sits between the Netherlands and Indonesia in the pecking order. That compares to $360B for Greece at its peak.

Like Greece, the issues isn’t the local economy, it’s contagion. Emerging markets with some similar strains to Turkey are also under major pressure. Currencies in Argentina, Russia, South Africa and Brazil fell 3-6% last week and most other freely-traded emerging market currencies fell more than 1%.

This is all leading to bids in the traditional safe haven currencies – the US dollar, yen and swiss franc. The most-obvious vector for contagion is via the financial system and European banks may be vulnerable and, by extension, the euro. The yen is higher across the board in early trading.

IMF Or Currency Controls?

In our experience, these are some of the most unpredictable events. Yet, considering the looming threat of capital controls, it’s not likely to be resolved before it gets worse but watch out for headlines about an IMF rescue. The latter would imply a bailout of as much as $40 bn but would necessitate higher taxes and lower spending, which Erdogan is sure to reject. The 10 Lira mark is considered a possible destination in the event of a continuation of the policy status quo in Ankara.

CFTC Commitments Of Traders

Speculative net futures trader positions as of the close on Tuesday. Net short denoted by – long by +.

EUR +11K vs +23K prior GBP -59K vs -47K prior JPY -63K vs -68K prior CHF -46K vs -44K prior CAD -25K vs -32K prior AUD -54K vs -51K prior NZD -25K vs -24K prior

Dollar bets generally increased but they were pared against the Canadian dollar and yen. What was left of euro longs was probably busted out late last week in the fall below 1.15 and yen shorts are now vulnerable.