Can you tell us about your career path so far?
I am a chartered accountant and an ICWA. I started my career with the mutual fund industry and I have been here ever since. My first assignment in 1993 was with SBI Mutual Fund (SBIMF) where I handled both debt and balanced products. In 1996, I moved to Sundaram Newton to set up the fund house's fixed income team. After having worked at Sundaram for about three-and-a-half years I moved to Kothari Pioneer (later renamed Pioneer ITI) in April 2000. In October 2002, I moved from Pioneer and joined Deutsche AMC to head the fixed income desk for Indian operations.
All the fund houses that you mentioned are quite diverse-SBIMF is a public sector fund, Sundaram is a small and conservative fund house, Pioneer ITI was known more as an equity house and Deutsche AMC is a new foreign player. How do you see the transition?
Professionally, from my point of view, the first change, of moving from public sector to private sector, was more intense with a better work profile, larger responsibility and an opportunity to handle an independent portfolio. This was something I was looking forward to do.
It was also exciting to set up and head a new desk. It worked out pretty well and I spent about three-and-a-half years there. We virtually began from scratch. At that point in time, the mutual fund industry itself was relatively small and we started the fixed income business in 1997 with just Rs 20 crore, which grew to Rs 250 crore by 2000.
In April 2000, I moved to Kothari Pioneer. Kothari Pioneer was known all along as an equity house and the question that you asked me is what I asked them. But they were very interested and were willing to even put in resources to grow the debt side of the business. At that time, almost 80-90 per cent of assets were in equity funds. Debt was growing across the industry and we introduced all different products-income, liquid and gilt funds. It was an extremely enriching experience. When I joined, the debt corpus was Rs 250 crore, and when I left in October 2002, the assets had grown to touch Rs 2,000 crore.
When Deutsche AMC approached me and asked me to head their fixed income department, the excitement of setting up something from scratch and of being part of a large global organisation excited me. It has been a reasonably satisfying experience so far.
Can you throw some light on your investment approach?
I have generally been an active fund manager. By active I mean that within the fixed income category, we tinker with our maturity a little bit, depending on the market conditions. Also, within the same maturity, we could move across different asset classes-government securities to corporate bonds or vice versa. But what remains at the back of our minds is that the core view on interest rates has to be respected.
When we started in January this year, markets were hunky-dory and the spreads across all segments were down. The term spread on the yield curve (the difference between 1-year and 10-year gilts) was 0.35 per cent. Even the credit spread between government securities and corporate bonds was the same. We had clearly thought that at 0.35 per cent credit spread, corporate bonds did not factor in all the risks such as illiquidity, credit risk, as well as the inability to transact larger volumes in that market. So, instead of corporate bonds we chose gilts of those maturity.
But come March, as we had expected, the spreads widened. Typically, two things impact the bond market in March-mutual funds face redemption and there is also a bunching of corporate issuers. There are a few PSU issuers who try to complete their borrowings before year-end. This means that there is a bunching of issues but mutual funds do not have adequate resources to buy. We adopted a contrarian approach. In January and February, we were overweight on gilts when the spreads were about 0.35-0.40 per cent. In March, when spreads were 0.65-0.70 per cent, we thought it was an opportune time to move out of gilts and move into corporate bonds. From there on, we expected that spreads will fall... spreads are already down to 0.40-0.45 per cent.
What kind of an investor are you? Being an active investor how much importance do you give to fundamentals and how much do you give to timing?
I would say fundamentals because without that you will never have conviction in what you are doing. I think even before you start building the portfolio it is important to have a view on where interest rates are headed and how you perceive the credit quality movement over a period of time. In that sense that is definitely the starting point. Timing comes in when you are building the portfolio, but it is not as important. The equation I would say is 80-85 per cent fundamentals and about 15-20 per cent timing.
You have been in the fund industry for 10 years now. How has your investment philosophy evolved?
What I have realised is that a lot of us in the industry spend too much time on the implementation part and too little time is given to developing a view. Typically, people just devote 5 per cent time to form a view and spend the remaining 95 per cent of the time in executing it. I think it should be the reverse. You generally find bond traders and bond fund managers on the phone all the time. While that is good as they are close to the market, but I think it is important to have a good core fundamental base. You have to know the macroeconomics, understand the environment, and get a feel of things. That is something that gets lost. What I have been trying to do-not that I can do it all the time-is to take some time out everyday and keep learning, verify my assumptions about the market, keep checking out the macro numbers and figure out if we are on course.
In your opinion where do you think the interest rates are headed?
The last few months have been a bit of a roller-coaster ride. But given the current liquidity levels, and the overall demand and supply of bonds, we can expect a steady market. The surfeit of liquidity provides support to bond prices.
Again, at a more fundamental level, the way things have unfolded pre-Iraq to post-Iraq is interesting. One, we are not going to see much fuel-price inflation. Two, we are also getting into a period of a slower economic growth globally. In certain parts of the world, it is because of the war and in other parts, it is because of SARS epidemic. So, central banks are likely to adopt an accommodative stand. You can expect a cut in the US Fed rate now.
India has already cut its rate by 0.25 per cent in April. In general, we are getting into a lower interest rate environment around the world. We are also getting into an environment of softer economic growth and lower fuel-price inflation. All these factors augur well for the market.
We also have a situation for almost a year where the local currency is fairly strong. Remember that we have been so used to the rupee depreciating by 4 per cent every year. That apart, we have also been in a situation where the balance of payment is favourable. In the last three months, we have experienced an average forex inflow of $500-$700 million every week. This forex inflow came in when oil prices were $30 a barrel.
Thus, you have a little more elbow room in the monetary policy as a result of easing of inflationary pressure after the US-Iraq war. With this background, I expect interest rates to remain soft in the foreseeable future. At a broader level, we are generally comfortable with current interest rates and we do expect rates to come down gradually. I will be happy if there is a 0.5 per cent drop in the current year.
In a benign interest rate scenario, what will your investment strategy be?
We generally avoid being extremely aggressive on the portfolio. We do believe that it does not pay to raise the overnight risk beyond a certain level. Any time, any event can take place, such as Iraq and expose the portfolio to high degrees of risk.
So the investment strategy is the same that it has been so far-manage the portfolio actively, do not raise the overnight risk level...but do look for opportunities that arise.
Can you give us your long-term view on interest rates?
Let us first look at inflation. Our country is going through some fundamental changes. In the past, we used to witness a sharp rise in the price of some commodity every second year. However now, there is stability in the supply of basic agricultural commodities. Thus, the most volatile portion of our inflation-primary articles, which constitute 22 per cent of the WPI-has been extremely well behaved in the last five years.The other segment of our inflationary basket is manufactured products. In the early 90s, they were linked to the domestic demand-supply to a very large degree and to a lesser degree to international prices, as we had high tariffs then. But with slower global economic growth and lower duties, this sector is more linked to international prices now. Manufacturing is going through a lull phase globally so even this segment of inflation should remain benign. So, inflation levels have certainly settled at lower levels and have also become much less volatile. That has helped in pulling down interest rates in the economy at a more fundamental level.
We have also seen a very sharp increase in our foreign exchange reserves. A country that used to have a few months of import stock now has several times the reserves that it had in 1991. We are fairly comfortable with foreign exchange reserves at $75 billion now. Due to this, the rupee has become steadier and has even appreciated in recent times.
In the early 90s, interest rates were held to ransom by inflation on the one side and by a volatile domestic currency on the other side. The central bank's policy around that time always favoured defending the currency, but suffocating the bond market. However, in the last few years that has not been the case and that has been the biggest factor leading to a bull run in bond markets of a magnitude which we haven't seen ever before. At a more fundamental level, the stabilisation and centralisation of inflation, ushering in a high level of policy change meant that interest rates have settled down at lower levels.
Soft interest rates have also coincided with a rather moderate growth this year in the manufacturing sector. Though service sector has done quite well, it does not require that much capital. So, the capital requirement for GDP growth is not so high. Thus even though the government spending patterns haven't shown any signs of improving, the low demand for capital from the manufacturing sector has helped.
What do you think can lead to a hike in interest rates?
While everything has been hunky-dory so far, there are some things that have been a cause of concern. We have seen successive CRR cuts in the last five-six years, but beyond a point there won't be any further cuts in CRR. So, that will take out an important cushion for the central bank. At that time, if there is a sharp industrial pick-up, higher investments, and overall activity in the economy, then we could have a situation of funds crunch. That is one scenario that will lead to an interest rate hike.
So one can witness either of the scenarios depending on how the government's policies pan out and how the different segments of the market respond to it.
From international investors' perspective, India does appear an attractive destination even for fixed income investments than before. From the fixed income point of view, there are some things that have happened. India has been in a unique situation where we saw a downgrade of the local currency in September 2002 and an upgrade of the foreign currency rating in February 2003. How can a country which is credible for its foreign currency rating not be credible for its local currency rating? That is because our forex position has improved dramatically. If flows continue at the same levels and the credibility of India improves in the international assets market further, even foreign institutional investors may find Indian fixed income attractive. India is finally coming out of the standard pattern of 4 per cent depreciation every year, which would have shaved off the earning. From there if you are getting into a situation where the rupee is steady and positive, then, of course, the Indian interest rate of 6 per cent looks attractive, particularly when you compare it to the region around us.
The fixed income fund investor has had a party for the last three years. What should he expect now and what is your advice for him?
My advice is that after the party, you should sober down. A prolonged bull market numbs your sen-ses. To a certain extent it affects everybody-bond traders, bond fund managers and even investors. It is not a healthy thing to have. Beyond a point, you have to be prepared for the downside.
It is important to temper down expectations. We are nothing but a product linked to the market. The last three years have been bumper years and investors have really benefited, but that is of course, not something sustainable. You cannot have a fall after the fall of interest rates, and of that magnitude. Now we are moving towards a stabilisation phase and there is a need to stabilise expectations too. The years of double-digit returns in bond markets are clearly behind us. But at the same time that doesn't mean that we will be the odd ones in the market as funds. We will give returns that are still comparable to other savings options. The investor should come from reasonable return expectations rather than heightened expectations.
An investor should also look at other benefits that a mutual fund offers besides returns like the convenience of investing any amount or withdrawing any amount at any point in time, which you don't get anywhere else without any penalties by and large. The other benefits such as a wide array to choose from, extremely convenient products, transparent disclosures, tax advantage-all these have to be paid attention to rather than just returns. That would still make it a case for them to look at bond funds. But would bond funds outperform fixed deposits by 6-7 per cent? The answer is no. If we are helped by a moderate decline in the interest rate, we will outperform fixed deposits and even if interest rates stay steady, on a tax-adjusted basis, we will outperform fixed deposits. On top of that, this is an unfixed deposit as you don't have to invest for a term.
What is the magnitude of risk in fixed income funds in the event of an interest rate hike?
Let me address this in the context of different funds, based on their portfolio right now. One virtually sees no risk of capital erosion in liquid funds the way they are structured right now. A good, solid part of their earning are floating-rate-linked. The rest of their earnings are linked to short-term instruments, which even in the worst of circumstances can't jump around too much to impact returns. For short maturity funds, generally portfolio duration in the industry would be around one-to-one-and-a-half-years, which would mean that if rates move up by 0.5 per cent, the funds could be out of money for a month. Income funds have a duration of four-five years, and if interest rates rise by 0.5 per cent then the funds could be out of money by 2-3 per cent. If rates stay at those levels for a prolonged period, then it will take them two-three months to recoup the loss. That is how the equations are, but that's only if something unpredictable happens.
Ask Value Research 
New episodes every Friday 
New Process Alert 
Seems like you've uploaded a wrong QR code. Please upload the QR code downloaded from MF Central platform.
