State government bonds  more popularly called state development loans (SDLs) seem to be the red-hot favourite for insurers and pension fund managers when it comes to investment returns.

Their sheer ease of availability and minimal risks explain why insurers are often in a rush to pick up these bonds. Additionally, SDLs measure up to the demand for long-dated assets to match their long-term liabilities.

A supply shortage of long-dated securities means Life Insurance Corporation of India (LIC), the state-owned life insurer, gets to invest quite often in SDLs. We keep investing in state government securities and get to invest every month to the extent of Rs 10,000-12,000 crore, said an LIC official.

Even private players are warming up to this investment option. SDLs provide a good opportunity for us to park money in better asset classes with good yields within the permitted basket of G-secs, reasoned Ritu Arora, CIO, Canara HSBC OBC Life Insurance.

SDLs basically are market borrowings of state governments to fund their respective fiscal deficits. The Reserve Bank of India (RBI) monitors and manages the issue of these securities in accordance with the limits set for each state by the Planning Commission every year.

For instance, Future Income Fund from Future Generali Life has a maximum exposure of 26.65% to SDLs out of 28.38% investment in G-secs and for ING Lifes ING Preserver Fund, around 13% share is invested in SDLs. Similarly, IDFC Pension Fund has a substantial exposure to these securities in the investment basket.

State bonds are also coming up as a preferred destination to park funds from traditional and unit linked plans (Ulips) alike. Since coupon rates are higher here as against central government bonds for the same maturity period, insurers load up in anticipation of better returns. Interest rates for sate government bonds are 50-60 bps higher,added the LIC official.

The numbers back up this flow. RBI data show state governments grossed Rs 1,58,600 crore under the market borrowing programme in fiscal 2012, up 52.5% in the corresponding period of the previous fiscal.

Experts feel insurers have limited room to park money in debt instruments due to regulatory firewalls. Insurance Regulatory and Development Authority (Irda) mandates all insurers to invest only up to 10% in AAA-rated corporate bonds.

According to the regulations, 50% of the funds from traditional plans should be kept in government securities, of which half should be compulsorily marked for the central securities.

Under the G-secs basket, bonds with a tenure of more than 10 years are less. That’s precisely why insurers think there is a mismatch between asset and liability as they underwrite contracts that typically exceed 10 years. In the case of traditional plans, you have long-term liabilities exceeding 10 years, the demand from insurance companies and pension funds for the central government paper becomes too high. Though the supply of longer maturity securities is increasing, it’s still small compared to the demand, said Nirakar Pradhan, CIO, Future Generali Life.

http://www.dnaindia.com/money/report_insurers-raise-a-toast-to-state-bonds_1794452

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