Macro indicators like the CAD and fiscal deficit have improved a lot recently helped by falling crude oil prices. Does this change the outlook for the debt market?
We have to look at various parameters and not just a few data points. Declining oil prices, de-centralised diesel prices, some control on the subsidies and a normal monsoon means that things are looking quite good at this point of time. With an improvement in economic activity, we expect tax revenues to be buoyant.
The Finance Minister has already shown that a 4.1% fiscal deficit, which was daunting challenge in July, now looks easily achievable. So, clearly we are moving on the right track. Institutional investors have shown a lot of confidence, year to date (YTD), they have pumped around $ 23 billion in Indian fixed income assets. The government is in a much better position to implement reforms and we are hopeful that next budget will move forward fiscal consolidation.
Do you now go with the consensus that interest rates have peaked and are likely to fall. Do you think long term bond funds and gilt funds are likely to witness a ‘secular bull run’?
Yes, if interest rates are going to decline than we might see a secular rally in the bond markets. I see yields of 1o year government bonds touching 8 per cent by April 2015. Any further decline will be based on falling inflation going forward. As we all know, the Reserve Bank of India (RBI) has an 8 per cent inflation target by January 2015 and 6 percent by January 2016. For us to achieve that 6 per cent we will have to see a significant decline in inflation going forward.
What impact will US rate hikes and the end of QE have on Indian gilt and bond markets?
From what they are communicating, I assume they will hike interest rates in a measured way and that might have a minimal impact on markets. I do not see any major negative impact on emerging markets based on Federal Reserve (FED) raising rates in 2014 and 2015. In case the Federal Open Market Committee (FOMC) picks up the pace, (which market participants are notexpecting) then there might be some risks. But at this point of time we are going with expectations that FOMC will raise rates in measured way. I do not see kind of collateral damage to Indian markets like we saw around June-July 2013.
With falling inflation, when do you expect RBI to begin rate-cutting?
I think the stage is set for a rate cut in India. The Reserve Bank of India (RBI) was focusing at two issues and they have articulated the same in the monetary policy. The first is inflation, which is the local factor and their last communication was that inflation still remains high. So clearly, they have set their objective for inflation to be below 6 per cent. For inflation to come down to 6 per cent, it will take some time.
To make that happen you need to have combination of prudent fiscal as well as monetary policies. I think that process is working very well. Based on all this, we believe that RBI has got some options for a rate cut but these will be available only in the January-March quarter.
How are you positioning your debt funds for the changed situation?
We have started to gradually increase duration across our funds. We believe that investors will potentially benefit from the decrease in bond yields in reaction to expectation of rate cuts. So across all our schemes, we have started increasing duration and taking on more risk. With improvement in credit cycle there are more ‘upgrades’ than ‘downgrades’. Having said that, we are looking around for potential risk which can be stabilized by these kind of views. So we have a balanced approached and not going one way. In most of the funds where we can increase duration, we have increased our exposure in government bonds. For example, the DSP BlackRock Strategic Bond Fund has over 60 per cent allocation to government bonds as on November 2014. In DSP BlackRock Bond Fund, our allocation to government securities have increased to 70 per cent in the same period. These are two income funds where we have already taken higher exposure and are trying gradually to increase average maturities further.
What is you view on recent tax changes on debt funds? Has the move led to redemptions out of liquid/short term funds? To what extent?
In my opinion, so far it has had a profoundly positive impact on investors thinking about investing. The centre of gravity which was one year fixed maturity plans (FMPs) will now shift to short term fund or income funds. The way interest rate cycle is about to turn, I think investing in longer duration funds will be beneficial for investors. Very clearly, we see this step as a positive direction from the government. It will take some time for investors to adjust to new regulations, but it will be an easy shift. As far as redemptions are concerned we haven’t seen redemptions in our liquid or short term funds. The only category which might have been affected is FMPs, where investors have taken out their proceeds and started investing in equity funds or income funds.
A few months ago, you expressed the view that it is best for investors to take advantage of corporate bond yields and earn higher accruals rather than bet on falling rates. Has that view changed?
No, our views haven’t changed. In fact, you will be surprised to know that we have done a small analysis on year-to-date (YTD) spreads of corporate bonds. The analysis shows that spreads of corporate bonds have tightened and have done better than government bonds. We continue to believe that in the current phase, credit spreads will continue to tighten because of higher demand and lack of supply. If one has higher average maturity in corporate bonds, then the price appreciation will be higher when compared to government bonds. Also, coupon is also high in corporates bonds, so there is dual benefit in looking at bonds issued by corporates.
What is your framework taking a credit call today? What kind of credit risk do you not take at all?
Normally, we look at two to three years because we believe that Indian interest rate cycle is very short and within that time we can look at a full cycle. As far as investment goes, we are not partial to any sector. In each and every sector there are ‘good companies’ as well as ‘bad companies’. As a fund manager, our main focus is to look for ‘good companies’ and ignore ‘bad companies’. Apart from that we have a six member risk and quantitative analysis team and their job is to look at risk associated with credit. Once we decide to invest in papers of particular company, the risk and quantitative analysis team is responsible for meeting the management, looking at financials, going through rating rationales and talking to sell side analysts to know about the company’s prospectus. The team will do lot of number crunching and analysis and will again represent their case to the investment committee. All factors are discussed and debated again and later if they find merit, limits are assigned for particular companies/sectors. After investing, we also track that paper on a continuous basis.
Which debt funds should an investor go for today, for the short and long term goals?
I believe that, currently it’s the right time to invest in duration funds, but investment horizon should be above one year. Anybody who wants to invest for less than one year should opt for liquid or liquid plus funds. But they should keep in mind new tax rules before they invest for less than three years. Depending on their risk appetite, investors can consider investing in short term funds or income funds at this point of time. We expect short term funds to generate returns in the range of 8-9 percent over the 1 year period. They make an excellent choice for investors who used to invest in bank fixed deposits (FDs) due to diversification as well as indexation benefits. It’s an appropriate time for investors investing in FDs to consider short term funds. Investors already having exposure to short term funds should look at investing in income funds and optimize their returns, with an investment horizon of two-three years.
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