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No Risk Free Returns

If investors are looking at only returns, then they have to accept extra risk, say India’s leading debt CIOs…

Fixed-income fund management is passing through an unusually interesting time. As the central bank raises interest rates relentlessly, fund managers are scrambling to stay one step ahead. In our roundtable discussion with six of the leading fixed income Chief Investment Officers of India’s mutual fund industry, readers get an insight into how investment managers are dealing with the new world of rapid rate changes and a new risk landscape that doesn’t look like becoming easier any time soon

Ritesh Jain:We have all learnt that change is constant in our market. The financial market comes with a degree of volatility and we have learned to kind of live with it, but it is imperative at the same time for investors to know that nothing comes free in life. If they are hell bent on looking at only returns, then it definitely comes with a degree of extra risk that is there in the portfolio, that I presume they have learned after 2008 for sure. It’s not only the fund manager who has to be blamed for taking an extra amount of risk in an effort to generate extra amount of returns in the portfolio. It’s the demand of the industry, it’s the demand of the investors which basically forces fund managers to take that risk...

There are around Rs 6 lakh crore worth of fixed deposits, say if it is going to be Rs 1 lakh crore worth of...

Navneet Munot:Take just bank savings deposits. We have money market funds that today are as safe. Of course, there are guaranteed interest rates which are not there in money market funds but given the kind of regulatory portfolio restrictions that are in place, and the kind of credit quality which is there in the portfolio, you can put in a redemption request and get your money back the next day. Now there are direct debit and credits and it’s hugely convenient in terms of putting in or withdrawing your money and the returns differential. But still we have not been able to get that critical mass. Somewhere the industry needs to work a little more in terms of making it more popular. Technology can play a better role and we should be able to integrate it with the banking system far more seamlessly, like it works in the US. If regulation becomes a little more conducive from the central bank as well as the market regulator, then a money market fund would compete with a savings bank deposit.

Ramanathan K:It is bound to work. The current savings account rate is 4 per cent, but the return in a money market mutual fund is 8.5 per cent. If cheque writing facilities are provided, something that mutual funds have requested but are denied, you can be rest assured there will be a lot of the banking money going into these funds.

Dhawal Dalal:If you look at the mutual fund assets, more than 80 per cent of them are in Tier I cities. There is a lot of potential out there which we have not been able to reach primarily because of cost and other reasons. Technology enablers have to be allowed by the regulators and it should be accepted by the mutual funds. Even right now, we have to have a physical paper to invest in mutual funds. Why? For instance, an investor should be allowed to just go on a platform, select the fund and the amount, just like you buy a railway ticket and the money should be debited from his savings account and the mutual fund units credited to his demat account. Technology is there, we just have to embrace that. The moment this becomes streamlined, all this can be achieved. Investors know that there is a benefit out there. It’s just the logistics and the other issues of delivering that physical paper which is probably detrimental to investment habits.

Kumaresh Ramakrishna:Mutual funds, particularly with the fixed income side, are pushed products. I don’t think anyone wakes up in the morning thinking I don’t have a cash fund in my portfolio, I need to buy one today. This is unlike equity where you always have somebody saying that they need to put my money in the market. That’s why I think convenience is most important and technology can bring about that. For an investor who has a savings account, there is a lot of inertia for him to move that money to a liquid fund. But if technology made it really easy and simple to do so, he would probably move in and out quickly.

There is complete consensus among all of you about the rate outlook and credit view. How do I evaluate, make a choice between funds?
Dhawal Dalal:I think every mutual fund manager has a different view and it’s ironic that many mutual fund houses have multiple funds in the same category and all of them are managed differently. So what comes out to a lay investor if he looks at the same fund house having three different portfolios of three different durations in the same category, say income or gilt, it does not give him a very convincing answer that the fund manager has a view. All he is trying to do is maybe just toss it around, if interest rates go up one fund will do well, if interest rates go down, the other fund will do well. This is the lack of conviction that the fund managers are not able to exhibit to the investor. One thing that has to be done at one level and SEBI tried it earlier is consolidation of funds, not only in equity but also in debt. You cannot have many funds because you are diluting your own credibility.

Ramanathan K:It is a commodity, a liquid fund is a commodity, an income fund is a commodity. The only difference is the track record and the consistency of calls. It’s a bit difficult for fund managers to manage an income fund in India vis-à-vis elsewhere in the world, the key reason is because we are expected to give high absolute returns all the time. For instance, say on a particular day you find that X income fund has a 6-month average maturity but Y income fund has an 8-year average maturity because the fund manager is more optimistic on his outlook on interest rates. Such huge distinctions and differences in durations you won’t find anywhere else. And the key reason is because our portfolios are expected to be positioned in such a way that we make money if interest rates rise or fall. So it’s an absolute returns market and absolute return is what investors look at. Globally that’s not the case where you just have to beat the benchmark.

Dhawal Dalal:The problem right now is that institutional investors have easy access and exit, no loads. So if there is a rate hike, an investor in an income fund will redeem and switch to a liquid fund. So suddenly you have redemptions in the income fund where you are managing high duration and inflows in the liquid fund. That’s why some of the mutual funds try to manage different funds in such a way that money remains within their house.

Ramanathan K:Today, you see that at least 60-70-80 per cent of short-term income funds have an exit load of at least 50 basis points for 6-9 months, then 1 per cent or whatever. That is a sea change because that clearly sends the message that fund houses don’t want short term funds.

Is there a way to differentiate between individual and institutional investors, the way they come and the time during which they stay?

Dhawal Dalal:If you allow a retail fund with all retail investors and if you also allow an institutional fund where all investors are institutional and let the fund manager run these two funds differently, I think that will be a great solution. Unfortunately, SEBI has shot down this idea right from the beginning that you cannot have two different funds. For example, right now, we are approaching a quarter end and an institutional investor is likely to be redeem. So we could let that fund run on low duration and the fund for retail investors, who are likely to remain, can run on a higher duration.

Navneet Munot:What about economies of scale, the cost of running it, the cost of acquisition? The kind of expense ratios we charge are very, very competitive...And because of the huge amount of institutional inflows, the retail investors can get the benefit of investing in such a fund at such a low cost because the institutional flows help subsidise the cost.

Ritesh Jain:Our idea is that basically the plans should not be segregated based on retail or institutional. The way to segregate must depend upon the mode the money comes in. So if it comes through distribution wherein the cost of acquisition is higher, then it comes in, say, Plan A. If it’s money that comes in directly, it goes to Plan B, wherein the saving in my cost can be passed on. So the point is that even a small amount like `1 lakh which comes directly to the fund house can be put in plan B. There are two markets which we cater to. I may not have direct distribution capability in a lot centres where I am dependent on distributors.

Where do we go from here in terms of rate hikes….

Ramanathan K:From my point of view, RBI has overshot. Yet, I do not see interest rates coming off significantly. I see the RBI easing liquidity possibly in the first quarter of next financial year and rate cuts will take some time, not before the second half of next year.

Navneet Munot:I would be surprised if we see a policy rate hike. Bond yields are headed lower across the board so there are lots of opportunities in the government and corporate bond markets. If you want to take a little risk, short term funds offer a lot of good opportunity. If you have a slightly longer horizon and a good risk appetite, then bond and gilt funds.

Ritesh Jain:There are risks on the horizon, specially in the way inflation has been handled. Inflation is excess of demand over supply. In the last six quarters we have raised rates by 350 bps to handle one side of the equation which is demand. And I really fail to understand the hue and cry about demand. What is wrong in the common man shifting his dietary patterns from, say, cereals to protein? What has been done to handle the supply part? It will hurt us, if not now then in the future. The situation will continuously remain on the horizon because we have not taken care of the intrinsic problem which is supply.

Kumaresh Ramakrishna:RBI tried to halt consumption by rising rates. But investment reacts faster while consumption continues and the capex, needed to take care of rising demand, doesn’t happen. So supply side takes longer to correct.

Navneet Munot:It is time to promote SIPs in bond funds. We tell people not to time the equity market because you never know when it will peak or bottom out. In fixed income everybody wants to know when the 10-year yield will peak and accordingly want to act. They should have a longer term view on bond funds. As a part of your asset allocation, if you as an individual investor have decided that you are going to be 50-60 per cent in an income fund, it is very difficult that take a call that this is the time to put money in and this time exit to some other asset class.

Kumaresh Ramakrishna:We meet a lot of HNIs and they have been doing SIPs into income funds over the past one year. In their portfolio they have FMPs and income funds. So they are well positioned. They may take a short-term loss but when the tide turns, they benefit because they do not want to wait for the FMPs to mature to reinvest money into the income funds.

Navneet Munot:Cycles are becoming shorter. Markets are getting more volatile. The importance of asset allocation cannot be undermined. While a savvy investor can have some amount of tactical allocation, strategic allocation is mandatory.

The downside from these levels looks limited because interest rates are peaking. The issue is that there is no demand for money. We talk about RBI hiking rates but the actual demand for money is coming down and that’s reflected in the market. So it makes sense for people to invest in income funds and duration products. Invest in those with mark to market component because it will give you the additional alpha.

Dhawal Dalal:I hope fund managers have the courage to run their portfolios mark to market. They should be willing to take the pain and given the gain. Primarily they don’t want to scare the institutional investors by showing unnecessary volatility. We have liquid funds where we are not running high duration. If everyone is so bullish about it then how come the duration in ultra short-term funds is not high? That shows they do not want to show volatility in the performance. Because they want investors to stick around and they are afraid to increase duration to a certain extent because even on a weekly basis there could be volatility in performance.