Insurers, fund houses cut debt paper duration

Insurance companies and fund houses have reduced the average duration in long-term funds due to the changes in monetary policy formulation proposed by the Urjit Patel committee and the recent rate-hike by the Reserve Bank of India (RBI).

Insurance companies and fund houses have cut duration in the range of one to three years. Debt experts will take a fresh view on duration once the government’s market borrowing for the next financial year is announced in the Union Budget.

Suyash Choudhary, head (fixed income) at IDFC Mutual Fund, said: “Since the Urjit Patel committee report, the focus on a particular inflation target will be higher. Although it is a flexible inflation targeting approach, because of that, we have also moderated duration along with the industry.”

Choudhary explained that keeping in mind the new focus on monetary policy along with emerging market currency volatility, they have reduced the duration on long-term funds.

Duration is a measure of the sensitivity of the price of fixed-income instruments to a change in interest rates. For fund houses, the average duration in long-term funds currently stands at 4-5 years.

“In the industry, duration has been cut by fund houses between one and three years. The reasons are clearer focus of monetary policy on controlling inflation, emerging market currency volatility, and the fact that new supply calendar starts from April. So once the auctions for the next fiscal are priced in to yields, fund managers may take another call,” Choudhary added.

Insurers and fund houses began cutting down the duration two weeks ago, due to the Urjit Patel committee recommendations on Consumer Price Index (CPI) inflation based monetary policy and RBI’s decision to increase repo rates.

The Street was earlier expecting a repo rate hike in December 2013, but RBI decided to maintain status quo. In January this year, when economists were of the view that a status quo was likely, the central bank decided to raise repo rate.

“Daily mutual funds are net sellers in government securities. Even in corporate bonds, too, fund houses are selling. This is particularly after the rate hike of 25 bps by RBI,” said Dwijendra Srivastava, head (fixed income) at Sundaram Mutual Fund.

According to insurance industry sources, while life insurers may look at an average tenure of six-to-eight years, general insurers would prefer shorter tenures of one to two years. This is because according to the Insurance Regulatory and Development Authority (Irda) rules, life insurers cannot focus too much on short-term and very short-term durations as part of their asset liability management.

“The 30-year bond is now being stayed away from, while a reduction of 12-24 months is a strategy being adopted,” said the senior investment official with a private life insurance firm.

Badrish Kulhalli, head of fixed income at HDFC Life pointed out that mutual funds have been selling government securities of longer tenures. “However, this is a short-term call due to the recent repo rate hike by RBI and lowered expectations of a rate cut by the central bank in the near future.”

While Kulhalli said the reduction of duration in insurance space is minuscule, he explained this was happening in the unit-linked insurance plan (Ulip) fund space.

The asset liability management (ALM) over a long period of time is more difficult than over a short period. This is due to market volatility and long-term nature of the bonds.

Nirakar Pradhar, chief investment officer at Future Generali India Life Insurance, said there is more overweight on the short- and medium-term duration now. He added the risk is much higher in longer tenures and, hence, there is demand for higher returns. However, with higher returns not being available with volatile market conditions, players are reducing the duration.

“The durations have gone down, on an average by one year in the last seven-to-15 days. However, most of this activity is restricted to the Ulip portfolio, since traditional portfolio has to rely on longer-term funds leaving lesser possibility of short-term bonds,” said the chief investment officer of a private life insurance company.