How do you evaluate corporate bonds for your funds' portfolios?
Managing credit is a very technical function. At ICICI Prudential, we have built a structured process around our asset-selection exercise. We avoid concentration risk by adhering to the investment limits, with adequate diversification and tenor restrictions.
There are two independent teams involved while investing in corporate bonds: the Origination Team and the Credit Team. The latter is independent of the fund-management team. It is a specialised 10-member team with cumulative experience of over 60 years in credit. It evaluates closely each investment in corporate bonds for its credit risk before it is added to the scheme portfolio.
Over the last one-two years, some asset-quality issues have surfaced in fixed-income funds. How do you ensure that such uncomfortable situations do not arise?
We seek to achieve safety, liquidity and returns (SLR) in that order of priority while managing a variety of debt schemes. We rely on internal research by conducting bottom-up analysis on the issuer. We believe external rating is just one of the filters while analysing an investment and therefore we do not solely rely on it.
We believe that performance is a function of risk. Therefore, it is important to manage the three critical risks: credit risk, liquidity risk and interest-rate risk. It is important to give due weightage to the credit quality of corporate bond funds.
Real interest rates have been on an upswing. In the last two cycles, whenever real interest rates were at the peak, G-sec yields fell. If the same story plays out this time, what debt funds are likely to perform better than others?
The RBI has been judiciously keeping the interest rates in line with inflation expectations. At the same time, inflation structurally has been falling much faster than the RBI's expectations (based on their various surveys). This has resulted in real rates becoming more positive. Historically, we have seen that whenever real rates have remained positive, fixed income has been the best-performing asset class over a period of time.
We firmly believe that the government's fiscal prudence and globally moderate commodity prices will structurally keep India on the lower side of inflation. As a result, interest rates in general will continue to moderate.
In such a scenario, the funds which are likely to perform better are medium- and high-duration funds for a medium-term investment horizon.
Now that the RBI has changed its stance from accommodative to neutral, how long do you think the RBI will be on a sustained pause?
The RBI's change in its policy stance from accommodative to neutral indicates that it wants to be vigilant and cautious about inflation inching higher from the targeted 4 per cent levels by March 2018. So, as long as the mandate remains purely on targeting inflation, the RBI is likely to maintain a cautious stance, with willingness to further ease monetary policy whenever it gets space to do so.
We are of the view that inflation is likely to remain well below the trajectory, as indicated in the last three policies by the RBI. We expect the RBI to change its stance towards easier monetary policy once it gets more surety on inflation coming in line with its targets. We expect that to happen by end of Q2FY2018.
Should retail investors change their debt-fund portfolios whenever there is a major fundamental change, like change in interest rates?
Investors should ideally maintain their debt-portfolio allocations based on their risk appetite and investment horizon such that their financial goals are met over a
period of time.
Do you think dynamic-duration funds are a good bet to wade through the current fixed-income market?
Yes, we think that dynamic-duration funds are more suitable because such funds give the fund manager higher flexibility to move the portfolio allocation as per the evolving market conditions and economic scenarios.
Fixed-income returns overall have been coming down. How should investors position themselves?
Fixed-income returns have moderated but we have to be mindful of the real rate that an economy can offer. In absolute terms, as the inflation rate tapers down, so will the nominal interest rates. But that does not mean that real rates have come down, which currently are in a range of 2.5 per cent. As we have seen moderation in retail inflation from lower double digits few years ago to current levels of about 3.5 per cent, it is natural for the nominal rates in the economy to also come down.
It is more important to keep stable real rates for investors, which will be useful for savers and for stability in the economy in the long term. Investors looking to invest with an investment horizon of three years can consider investing in short- to medium- or dynamic-duration funds.
Debt mutual funds have been slowly getting popular. But do you think guaranteed returns in other fixed-income avenues in India pose a challenge to debt funds?
Most investors tend to associate investing in mutual funds with investing in equity markets. However, mutual funds invest in other asset classes, like debt, too, which may be considered as an alternative to traditional fixed-return instruments.
Debt mutual funds typically help add stability to the portfolio in terms of returns profile. Secondly, they aid in the portfolio-diversification exercise, which comes in handy when other asset classes are not performing well. Therefore, we believe debt mutual funds can be effectively used for a achieving a variety of financial goals, including wealth creation.
What is the biggest lesson that you have learnt in your career?
One major lesson I have learnt is that while all variables may be in your favour, you may still be proved wrong. Hence, assign more weightage to the safety aspect while taking investment decisions.
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