Simplifying Short Term Income Funds

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Financial Savings of the Indian Household

Financial Savings Avenues Share (%)

Deposits 49% Over 80% of household financial

Provident, Pension Funds & Insurance 29%

G-Secs & Small Savings Schemes 3%

S & %

household financial savings are in

traditional Fixed Income avenues

Shares, Debentures & Mutual Funds 9%

Currency 10%Less than 10% of

Indian household’s financial savings is allocated to Mutual Funds and sharesSource: RBI; 2006-07

• Over 80% of Indian household’s financial savings is allocated to traditional savings avenues• Households continue to invest a substation portion in traditional fixed deposits • Mutual Fund Debt schemes have been traditionally targeted at corporates and have seen• Mutual Fund Debt schemes have been traditionally targeted at corporates and have seen very low participation from individuals

OPPORTUNITY: Attract household savings in to Debt Mutual Funds

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g

A more tax-efficient option to Traditional Savings Avenues: Fixed Income Mutual Funds

Liquid / Money Market Funds

Short Term Income Funds Income / Bond Funds G-Sec Funds

• Invests in a judicious mix of Corporate Bonds, PSU

Bonds Government • Invests primarily in • Invests primarily in

• Invests in short tenure securities and money market instruments

• Ideal short-term

Bonds, Government Securities and money

market instruments

• Able to take duration calls generally ranging

• Invests primarily in longer tenure bonds

• Invests mainly in PSU Bonds and Government

Securities – Private

Government Securities and Treasury Bills

• Volatile due to active trading in Govt. Securities

investment avenue for surplus funds

• Highly liquid

F i it l

g y g gbetween 3 months & 5

years depending on interest rate outlook

• Take advantage of credit d b t diff t

Corporates seldom raise issue bonds over 5 years

tenure

• Fewer opportunities to t k dit ll L

• Very sensitive to changes in interest rate

due to longer term duration of Govt.

Securities• Focus is on capital preservation coupled with

reasonable returns

• Returns closely linked to money market yields

spreads between different rated securities

• Regular returns through dividends

take credit calls – Lower order credit seldom issued

for higher durations

• More sensitive to any interest rate changes

Securities

• No credit default risk

• Suited for investors who want to actively time debt money market yields

• More tax efficient as compared to traditional

Fixed Deposits

interest rate changes markets

Disclaimer and Risk Factors at the end

Ideal Alternative for traditional Fixed

Tax Benefits from investing in Debt Mutual Funds

The Returns are assumed purely for illustration purposes only to explain the benefits of Double Indexation. The returns above should not be construed as indicative returns of the scheme. The Scheme is not providing any assured or guaranteed returns, neither forecasting any return.

#Please consult your tax consultant for tax implications specific to your situation. Highest tax slab has been considered.Tax rates are as per current law and can change from time to time

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**Investment assumed for the period March 08 to April 09 thereby availing of Double Indexation benefits. Cost inflation Index (CII) for FY2007-08: 551; 2009-10: 632

Performance Drivers for Short Term Income Funds

Accrual

FundFund Managers

use an optimum mix

of these drivers to

Roll Down Return

Durationdrivers to maximise returns

Credit

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Performance Triggers: Accrual

• Investing at higher interest rates would lock-in a higher portfolio yield leading to higher accruals in the portfolio (for all securities with maturity upto 91 days and for marked to market securities, when there is no impact from interest rate movement)

• For Mark to Market securities, the net portfolio impact would be accrual income plus or (minus) mark to market gains or (losses)

• When a bond is purchased, a portion of the yield is locked-in daily as accrual income till maturity

• Bonds purchased at a higher yield will accrue greater income every day resulting in a higher portfolio yield

A l b hi h l f iti f th t d di f dit• Accruals can be higher or lower for securities of the same tenure depending of credit, liquidity, issuer and type of instrument (Eg. Bonds, Securitized Debt, Money Market)

Accrual is the primary mode of income generation for Short Term Income Funds

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Accrual is the primary mode of income generation for Short Term Income Funds

Performance Triggers: Roll Down Return

• Roll down is the return component associated with a bond’s duration as it approaches maturity

• In general, longer duration securities held to maturity would have the possibility of capital gains due to higher coupon vs similar maturity securities towards the end of the tenure

Roll down in a FALLING Roll down in a FLAT interest Roll down in a RISING interestRoll down in a FALLING interest rate environment

• Example: Buy a 5 Yr paper trading at a yield of 9.5%

Roll down in a FLAT interest rate environment

• Example: Buy a 5 Yr paper trading at a yield of 9.5%

Roll down in a RISING interest rate environment

• Example: Buy a 5 Yr paper trading at a yield of 9.5%g y

• 1 Yr paper is at 9%

• Assume interest rates fall and 4 years later a 1 Yr paper is at

• 1 Yr paper is at 9%

• Assume interest rates are flat and 4 years later, a 1 Yr paper

g y

• 1 Yr paper is at 9%

• Assume interest rates rise and 4 years later a 1 Yr paper is at4 years later, a 1 Yr paper is at

8%

• However, the 5 Yr paper you had bought now has a residual

continues to be at 9%

• However, the 5 Yr paper you had bought has a residual

maturity of 1 Yr and continues to

4 years later, a 1 Yr paper is at 10%

• However, the 5 Yr paper you had bought now has a residual

maturity of 1 Yr and yields 9.5%

• POSITVE IMPACT ON PORTFOLIO

maturity of 1 Yr and continues to yield 9.5%

• POSITVE IMPACT ON PORTFOLIO

maturity of 1 Yr and yields 9.5%

• NEGATIVE IMPACT ON PORTFOLIO

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Roll Down Returns provide opportunity to enhance returns

Performance Triggers: Credit

• Markets present opportunities to take advantage of spreads between government backed

companies and private companies, similarly between higher and lower rated private

companies

• Credit Risk is the possibility of a loss occurring due to the failure of the issuer to meet

payments as promised

• The lower the credit of an issuer the higher the associated yield due to the higher riskThe lower the credit of an issuer, the higher the associated yield due to the higher risk

associated with holding the security

• Credit risks are a vital component of fixed-income investing, which is why ratings agencies

such as CRISIL, ICRA and Fitch evaluate the credit risks of issuers on an ongoing basis

C di b d ff i l h

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Credit can be used as an effective tool to enhance returns

Performance Triggers: Duration

• In general, securities of a higher duration earn a higher yield due to the longer maturity period associated with them

• Bonds / Portfolios with a higher duration are more sensitive to interest rate changes than lower duration portfolios

• As interest rates fall, bond prices rise resulting in higher capital gains being accrued to the portfolio

• As a result, in an environment of falling interest rates it is prudent to invest in a higher duration portfolio

• Conversely, in a rising interest rate environment it is prudent to be conservative by investing in a lower duration portfolio

D i k i i

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Duration management key to optimize returns

Key Trends and Indicators

Benchmark Rates March 2009 Current Change

WPI Inflation 1.5% 9.4% +7.9%

Cash Reserve Ratio (CRR) 5.0% 6.0% +1.0%

RBI Repo Rate 5.0% 8.0% +3.0%

RBI Reverse Repo 3.5% 7.0% +3.5%p

Statutory Liquid Ratio (SLR) 24% 24% -

Source : Bloomberg, Citi

Substantial rate increases have already taken place. Steep increases unlikely going forward

Disclaimer and Risk Factors at the endFor distributor circulation only 11

Why invest NOW in Short Term Income Funds?

1. In the current rising interest rate environment, investors should take exposure to the shorter end of

the yield curve as compared to the long end as they are less sensitive to interest rate changes

2 The yield curve is currently inverse to flat so short term rates are trading higher than similar2. The yield curve is currently inverse to flat, so short term rates are trading higher than similar

longer dated securities

3. Accordingly, Short Term Income Funds give investors an opportunity to take advantage of the

higher rates at the shorter end of the yield curve, thereby offering attractive returns

4. The current consensus is that interest rates are near their peak. In such a scenario Short Term

Income Funds which invest in higher maturities vs Ultra Short Term Funds would be beneficiariesIncome Funds which invest in higher maturities vs Ultra Short Term Funds would be beneficiaries

from falling yields

5. Good investment and trading opportunities exist due to mis-pricing between Corporate Bonds of

different highly rated issues

Short Term Income Funds make for a compelling investment opportunity given the current

interest rate scenario as well as from a long term fixed income allocation perspective

Disclaimer and Risk Factors at the endFor distributor circulation only 12

interest rate scenario as well as from a long term fixed income allocation perspective

Performance of Short Term Income Fund Category

• As a category, Short Term Income Funds have delivered consistent returns over the long term

• To illustrate, we analyzed the performance of ALL Short Term Income Funds* over a 3 Year, 5 Year

and 7 Year period (as on June 30, 2011)

3 Year CAGR 5 Year CAGR 7 Year CAGR

Best Performing Fund 9.7% 9.1% 8.0%

Wost Performing F nd 4 6% 5 1% 5 0%Wost Performing Fund 4.6% 5.1% 5.0%

Category Average* 7.6% 7.8% 7.1%Source: ACE MFPast performance may or may not be sustained in future.

• Short Term Income Fund category has returned an average of 7.8% CAGR over the last 5 Years. In

fact even the worst performing fund has returned 5.1% CAGR!!

• The category performance coupled with the additional benefits of liquidity and tax efficiency of• The category performance coupled with the additional benefits of liquidity and tax efficiency of

mutual funds viz-a-viz Fixed Deposits make Short Term Income Funds a compelling long-term

investment avenue

Di id d d l d b M t l F d t f i th h d f th i t

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• Dividends declared by Mutual Funds are tax-free in the hands of the investor

*All Short Term Income Funds, Regular Plan as defined by ACE MF