What is your view on the decision of the central bank to free interest rates? Do you think it will hit flows into liquid funds?
First of all, if you look at who the investors in liquid funds are, they are mostly institutional investors and the HNIs. The retail investors’ participation in liquid funds is relatively low at this point in time. Since incremental returns are better than savings bank deposit rates along with the benefit of daily liquidity and the amounts invested are fairly large, money finds its way into such funds.
So the freeing of savings bank rates may not have a direct and immediate impact on flows into liquid funds. However, it does increase the hurdle rate when talking about attracting retail money into liquid funds. Although the mutual fund industry as a whole would welcome retail money into liquid funds, now convincing a retail investor to invest in such a fund may become a bit difficult if all banks decide to raise their savings bank rates.
For us, the issue is not the savings bank rate but the fixed deposit rates. Traditionally retail investors gravitate towards fixed deposits. The comfort level is high - attractive returns, fixed tenure, they can be broken in case of emergency. That sort of comfort level that investors have with their banks is still to be gained by the mutual fund industry as far as liquid funds are concerned.
The PPF, fixed deposits and post office savings schemes form a large portion of the fixed income allocation of an Indian retail investor. In the past few years, they have even been active in gold, silver and real estate. However, we believe that this trend will change in the next couple of years as retail investors begin to invest more into mutual funds.
Do you think this move of the RBI this will have any impact on the retail investor in terms of deciding where to move his money depending on who is offering a better rate.
I doubt that retail investors will shop around for the best savings bank rate. We believe that less than 15 per cent of account holders are likely to switch to a bank which offers a better rate.
If one looks at the total NDTL of the Indian banking system, it is around Rs 56 lakh crore, of which around 25 per cent is in CASA. That makes it close to around Rs 13 lakh crore. If the savings rate is increased by just 1 per cent, from 4 to 5 per cent, then the net impact is likely to be around Rs 13,000 crore. Moreover, the average balance in a savings account is around Rs 30,000. So we do not envisage a change in the savings rate causing investors to switch from one bank to another. To add to it, many investors have signed up for their bill payments, SIPs and other auto-debits from their bank accounts, which may make it even more cumbersome to switch banks.
With inflation being the way it is, how challenging has it been for debt fund managers to give positive inflation-adjusted returns? Also, when you see the rates offered by bank fixed deposits.
It has been quite challenging. Inflation has been high over the past two years and it has been challenging to generate a positive incremental real rate of return. But at the same time we have endeavored to protect the downside for our investors.
During such times, the important thing is to optimize cash flows. Over a prolonged period such as this, an incremental performance of even 1 - 1.5 per cent makes a difference. When it comes to competing against rates offered by bank fixed deposits, it does remain a challenge as traditionally retail investors do favor fixed deposits.
What are the concerns you have when it comes to the Indian economy?
In order of importance, there are two main concerns. The first is the fiscal deficit and the other is inflation. The one point I’d like to add is that the Indian economy was doing well before the 2008 financial crisis. We were on track to achieve a fiscal deficit of close to 3 per cent of GDP. Post the crisis, the government had to provide economic stimulus to sustain the economic growth. However, it had contributed to an increase in the fiscal deficit.
There is also some concern on the external environment. For example, the price of crude at its peak had gone up to $140/barrel, came back to $30/barrel and now is back up again at $110/barrel.
As a debt fund manager, what is your biggest concern today?
Uncertainties. This year has been marked by a heightened level of volatilities across the board, in both domestic and international markets. We believe that it will not subside anytime soon. At the macro level, there is tremendous amount of uncertainties in global markets. Nowadays when a trader walks in on the trading floor, he has no idea in which direction the markets are likely to move on a given day. There are volatilities in the forex, fixed income and equity markets. This affects the thought process and no one can say with certainty what is likely to happen in the near term. So in recent times when investors ask fund managers about their views, it may not be easy for the fund manager to clearly articulate it in a concise form purely because there are so many factors at play which have an impact on the sentiment as well as markets.
You have voiced your opinion about how investors in equity can look at a past track record but the same does not hold in debt. Can you explain that?
It’s an important consideration. In India, diversified equity funds have delivered consistently strong performance over the last 10 years. This is mainly due to the equity fund manager’s ability to identify equity market cycles, stock selection as well as active management style. So if you like the fund manager’s investment style, his ability to invest in the right sector and his stock selection and portfolio management approach, then these may help you to decide whether to invest with him or not.
In the case of fixed income, the past performance may be less important. What may be important is the fund manager’s view on interest rates in the near term. And based on that view how he has positioned his fund. If the investor agrees with that view, his portfolio management and credit-risk management approach and if he feels it makes sense in the current environment, then he should invest with the fund manager and give him sufficient time to generate performance based on his views on interest rates.
What is your view right now?
Cautiously optimistic. We believe that risk-reward ratio is clearly tilting in favor of the investor based on the current term-structure of interest rates. We think that the interest rates are closer to their peak and inflation may be trending down gradually if there are no further supply shocks. Based on that, investors are advised to consider investing gradually in the long duration fixed income funds with an investment horizon of at least six months. We also expect the RBI to start cutting rates in the second half of 2012. If that happens, there will be a price appreciation in the government bonds, which in turn will result in incremental returns.
What separates a good fund from a mediocre fund in the liquid category?
Currently, there are around 40 funds in the liquid fund category. If one looks at their monthly (annualized) performance, the gap between the top and the average performance is sometimes just around 20bps. The major factors affecting performance are expense ratio, asset allocation as well as credit risk. Current SEBI guidelines however, have significantly reduced the duration risk. This has resulted in a significant reduction in the differential performance between the top funds and the average performance of the category. At times, fund managers can also look to generate higher returns by running low cash or buying high yielding assets.
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