Though not the first crop fund, it is certainly the largest in terms of assets and the boldest in terms of exposure to AA and below rated paper. Kamath speaks about this fund.
What was the thinking behind the launch of Templeton India Income Opportunities fund?
In 2008, in the midst of the global turmoil and the liquidity crisis in India, there was a huge amount of risk aversion in the system. The view was to stick to G-Secs due to the overall weak environment amidst fears of corporate defaults and downgrades. We felt the fear was exaggerated and misplaced, and hence held a slightly contrarian view. We did not believe that India had a huge amount of credit risk in the system, given that underlying fundamentals remained intact. We were, in fact, concerned about the huge government borrowings as a result of the fiscal stimulus programmes. So we maintained a very low maturity on our income and debt funds.
At that point of time, we also saw the spread on normal papers widening quite a bit, especially in some good NBFCs and PTCs. Now these were giving around 6-7 per cent over the G-Sec. So in January 2009, when a 10-year G-Sec was quoting at 5 per cent, we analysed the impact of a further 50 bps cut in interest rates and, even after considering the capital gains, we realised that the net yield would be lower than that achieved through a 1-2 year paper held till maturity.
The risk was that G-Sec yields could actually have gone up, instead of coming down. So we were low on maturity and in our short term income plan we had similar paper, which we believed was low credit risk but spreads were high. However, we felt that a retail-oriented fund that can invest in such papers and hold them till maturity had the potential to deliver superior returns due to these high spreads through accruals.
Your other short-term fund would not fill the gap?
Our Templeton India Short Term Income Plan had begun to grow - from around Rs 400-500 crore to close to the current Rs 3,600 crore, despite the monetary tightening cycle. But the fund had a limit of 30 per cent on our PTC exposure. We felt that a fund that can be flexible and where investors can stay invested for a relatively longer period can reap the benefits of higher accruals. So in December 2009 we launched the India Income Opportunities Fund, which is now over Rs 4,000 crore.
We also put in place a reasonably high exit load to discourage short term flows that could prove detrimental to our investment strategy. Overall, this strategy worked and the fund has been able to deliver a reasonably good performance since its launch.
What sort of credit risk do you take in India Income Opportunities?
We do not take undue credit risk in the fund; it’s more of a call on the spreads. We do not invest in low credit paper for higher yields. In 2009 investors became ultra safe and just bought CDs and PSU bonds, and we could invest in good credit paper at significantly higher spreads.
The fund has a substantial exposure to AA and A rated paper, not just AAA. We are very conscious of credit risk. When we move down from AAA to AA or A, we are very selective about the company we pick up. We also need to keep in mind that the rating changes lag the market; they are not leading indicators.
The fund does have exposure to SOs and PTCs as well.
Does that not make the fund riskier?
Exposure to SOs and PTCs does not make the fund riskier. The perception in the market was that these bear high credit risk. Not necessarily. They can be high credit papers and at times even more secure than certain AAA-rated papers, due to the way they are structured and the credit enhancement. If we look at the historical numbers, the probability of downgrade and default in securitized debt can be lower than in a normal bond. The fund currently has around 65 per cent exposure to AAA equivalents and around 24 per cent to AA equivalents.
If you only end up buying a PSU bond or CD or G-Sec or AAA paper, the investment team is not exactly looking for value add to a portfolio. One needs to evaluate investment opportunities on an active basis and take exposure on a risk-adjusted basis. We don’t take undue credit risk. For example, we never had any real estate exposure at any point of time in our debt portfolios.
In 2007, even when the general perception of Real Estate was very positive, we didn’t pick up any of the paper, because of our concerns regarding their fundamentals. This obviously helped us in 2008, when the crisis situation led to many fund houses needing to step in to plug the leaks due to real estate exposure. Even if you look at the current scenario, real estate companies are quoting below their earlier high valuations and at the same time, real estate prices in Mumbai remain high. This discrepancy cannot continue and fundamentals need to get aligned.
Why are you not more opportunistic with this fund? Credit opportunities funds in the West take big risks.
In India, we believe that a credit opportunities fund might not have a sufficient investment universe, unlike the West, where the corporate debt markets are far more mature. Most of the trading here takes place in the AAA and AA category. If one intends to buy a low graded paper and then plans to sell it when it gets upgraded, it could backfire if things don’t go as planned. In a developed market one can buy a CDS. Here there is no option and the RBI is looking to change that. If a call goes wrong it will impact the fund. Also, in a more developed market, AAA levels are so low that one is forced to take that much more risk generating some alpha. In India, you can get a return of 7-8 per cent on highly rated paper, so it’s not necessary to go down the credit ladder, especially given the depth and liquidity of the markets.