Unlike equity markets, it is not that good a going for bond investors tells Santosh Kamath, CIO - Fixed Income, Franklin Templeton Investments-India in this interview with Aarati Krishnan.
Equity investors are predicting a secular bull run after this election verdict. But how has this verdict changed the picture for interest rates and bond prices?
If a strong government is in place, there is a very high chance that good decisions will be taken and the economy will trend upwards. While that is good news for everyone, particularly equity investors, it isn't good news for bond investors. It means more demand for money, which usually leads to a rise in interest rates. At the same time if foreign investors like India, they will start putting in more money. So you will have a situation where inflation and interest rates move up due to the economy, but foreign investments flow in and lead to more liquidity. All this may not happen in a synchronised manner. Therefore, with both pulls and pressures on rates, I expect bond markets to be volatile. I feel interest rates do not have room to come down too much, though foreign investment flows can pressure rates in the short term.
The second factor which everyone is ignoring is the worry about the monsoon. Monsoons always have a large impact on inflation. If monsoons are weak, despite a strong government, you could see upward pressure on inflation as well as interest rates.
To put this very simplistically, I don't think this is the beginning of a long-term bull market in bonds.
But most bond fund managers are taking the view that interest rates will have to come down. The argument is that rupee has been appreciating and this can lead to the import bill falling and inflation cooling. So they feel RBI has no reason to keep rates high.
I don't think the rupee will appreciate too much from here. RBI has recently disclosed the REER (Real Effective Exchange Rate) based on the CPI and that shows the rupee to be overvalued by about 6 per cent. You should also remember that we have received a lot of NRI money in the form of FCNR B deposits last year. This money has to be repaid and RBI is aware of this. Therefore, when FIIs invest now, RBI will keep buying dollars to shore up reserves. We also need a weak currency to bolster exports. So, I think the rupee may retrace. We won't have a panic situation like last year, but the rupee may depreciate gradually.
So are you saying that interest rates will not fall sharply from here?
In the short term and technically speaking, they will fall. As FIIs bring in money, liquidity will be ample and rates may fall. But I don't think this will sustain for a long period of time as growth picks up and demand for money rises.
A lot of investors are today betting on long-term gilt funds to make capital gains when rates fall and bond prices rise. Do you think they are wrong?
It depends on what kind of investor you are. If your objective is to make decent returns over the long term, you should look at corporate bond funds or our short term income plan, which are invested in high-yielding corporate bonds and have medium maturities. If you don't want to take a call on the whims and fancies of the market, you can still make good returns from this segment today. If I am a conservative investor, I may prefer this strategy for my core portfolio. But investors who want to take a tactical view, may like to make trading gains on gilts or long term bonds. This depends on how well you can time it. Today I would overweight the first strategy because yields are so high. Normally, investors and distributors have a short term view so they think they should make trading gains. Over a very long time, it is very difficult for anyone to outperform the returns from a high-yielding corporate bond fund.
With the economy still in a downturn and corporate leverage at high levels, isn't it risky to invest in a high yielding bond fund? Aren't a lot of credit downgrades happening?
This is a much misunderstood part of the market. Somehow, the market feels that any bond which is not triple A is too risky. That means Indian bond investors or distributors may not be able to invest at all if they go to the US market because there, only five companies are triple A and they don't borrow money! Anything which is not triple A is not high risk. Yes, people keep comparing this situation to 2008 and worry about a repeat of the defaults that happened then. But risk is difficult to handle only if they crop up suddenly, not if everyone is aware of them and is prepared for it. In 2008-09, liquidity became extremely tight, even good companies were not able to raise money. Even in that period though, the number of downgrades that happened were not very big-about 15 per cent.
Today we have had a slowdown for a long period and so companies have reduced capex and cut costs. So according to me this slowdown is not as bad as that in 2008-09. This slowdown has impacted the P&L account, but it hasn't impacted balance sheets in a big way. I also want to clarify that we don't take credit calls in our fund. We lend to good companies in the expectation of higher interest rates. We don't invest in poorly rated paper hoping that it will be upgraded.
Recently, we have seen sector-specific debt funds come up, like Franklin Templeton's PSU and banking debt fund. What is the logic for such funds? If you feel PSU debt is attractive, surely you can buy it under your existing bond funds?
In India many investors, particularly small and mid-sized corporates have mandates that do not allow them to buy any bonds outside of PSUs or banks. We found that such corporates do have an appetite for debt funds. Therefore we launched this fund so they could take advantage of this opportunity. By offer document, this fund restricts its investments to PSUs and banks. In other funds we may move opportunistically in and out of these sectors.
So, does your interest rate view mean that you are not really holding very long maturity bonds or gilts in your Templeton Income Builder Account or Templeton India Income Fund?
We do. We have clearly segregated our debt portfolio into high credit products and managed credit products. So Income Builder Account (IBA) is a managed credit fund and Income Fund (IF) is a high credit fund. So high credit means PSUs and banks and so on and managed credit refers to corporate bond exposures. Then we have also classified them into short-, medium- and long-term funds. Income Fund is a high credit fund and IBA is a managed credit fund. So in the IBA, Templeton Income Fund or the G-Sec Fund, we do run long durations. But in our corporate bond fund we won't take that call.
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