How has the debt market evolved in the past ten years?
If you look at the debt market in India historically, it has been highly regulated by the RBI. There were controls on both deposits and loans. Banks and insurance companies were the only investors in the fixed income markets. As liberalisation progressed, banks started getting more leeway. Today, except for the bank savings account and a few administered products like RBI Relief Bonds, all other rates are left to the market. These steps allowed a new breed of investors to enter the market; there were players like mutual funds, investment companies and corporates. Insurance companies too increased their participation. In that sense, the market is far more complete today.
Interest rates in India were historically pretty high as we had high inflation. In 1999, we were buying a 10-year bond at 12 per cent. Today, that bond is about 6.5 per cent, and a year back it was 5.25 per cent. Yields have gone down sharply. We have moved out of double digit inflation to mid-single-digit inflation and when people talk about inflation today, they peg it at 4-6 per cent. We have significantly loosened controls on capital inflows into the country; our reserves which were not even two months of import cover 10 years back, are now at 18-20 months of import cover. All these factors have resulted in global investors looking at investing in India seriously. The emergence of so many market players has caused interest rates to move in line with fundamental factors.
Where are interest rates headed now?
That is a million-dollar question. We really don't think that rates are going to move up in a big way in 2005-06. While credit growth will remain robust, it may not match up with the growth in credit during 2004-05. At the same time, you will have the benefit of lower average inflation as compared to this year, because a lot of the high inflation is already factored in. At the same time, foreign institutional investors continue to pump in money-though it is mainly in equities. There is a possibility of a repo rate hike in the Monetary Policy by 25 basis points. Everything put together, I think, rates should be between the 6 and 7 per cent band this year. So, interest rate is unlikely to go above significantly above 7 per cent even if things go bad, and they will not go below 6 per cent even if the situation improves.
That will happen only if inflation-oil inflation and metal inflation-takes off sharply across the world. Or if central banks globally start jacking up interest rates. That seems unlikely right now. At present, the only region to increase rates is the US. There is weak data coming from Japan, which has seen four successive quarters of degrowth. Europe is still struggling to reach the growth path, so there is no immediate threat of a rate hike there. The US, though, will keep hiking interest rates, as rates need to be brought to a more normal level there. In India, we are likely to see a 25-basis-point hike in repo rate due to higher growth rate and credit pick-up. Beyond this, we are unlikely to see a rate action from RBI, based on current factors.
What investment style do you follow in your Income Fund?
Our income fund has been focused on meaningful duration calls. We have not gone down on the credit curve except the occasional AA+ or AA paper. Basically, we have been AAA investors. If you look at our performance, it has been top quartile since inception, which is a period of about four and a half years. Obviously, the performance shows that we have taken some good duration calls. We also tend not to be as volatile in our management and we try to get a more stable feel of markets. Therefore, if I may use the term, we tend to pay less to the markets by not changing our positions too frequently. We make a duration call and hold on to it and see if it is working or not. That is what has helped us deliver competitive returns. I don't think our management style is going to undergo a drastic change and we will continue the same style in future. We still don't feel that the environment in India is good to invest in securities that are below AA. We will stick to what we are doing and what we know best. I am confident that this style will give us decent competitive performance.
Your income fund has generally had lower than average risk. Are you conservative?
Not necessarily. If you look at the interest rate cycle in the last four years-the ten-year yield has drop from 10.5 per cent to 6.5 per cent-we have outperformed most of our peers. We would not have been able to outperform our peers at a time when the markets are doing so well by being conservative.
Yes, our average maturity has been lower than competition. Maybe we are paying less to the market (in terms of buy-sell spreads) by not changing our portfolio stance that frequently. Take the case of a fund manager who is buying a lot of long duration calls; maybe he is shuffling his portfolio too much as he is carrying more risk and hence ends up paying more to the market. Or, maybe he trades on 15-20 paise moves and cashes in every now and then. We have not done that; we have stuck to our position and got most of our moves right. As we also do not carry a lot of duration at any point of time, we do not sell at every downtick either. We are comfortable vis-à-vis the market and what we should be doing. This way we save the fund some amount of impact cost and brokerage. Perhaps, that's where the success point lies. Yeah, so on an average if you look at our performance, considering that yields have fallen, one would assume that we would be long duration players, but that is not the case. So, even if we bet duration, there is a certain amount of value proposition in it.
We have done well with that fund too. We started off on a weaker side with Principal Income Short-term. While we had a cap of 18 months on our portfolio maturity, the other portfolios did not have any such limitation. In 2003 and 2004 interest rates were dropping fast, and some of our competitors were holding maturity of even three years. That was the time when we passed through the most stressful period. We were under pressure from our sales people, and from our competitors to match their returns. But we were not willing to compromise on the profile of the portfolio-it is a product where the interest rate risk should be limited and we stayed true to that. Thankfully, we stuck to our stance and we had a wonderful last 12 months. Our stand of buying lower duration but higher carry assets helped us and we are today one of the best performing short-term funds in the industry. We think that there is no need to change that even if there is a bull run tomorrow. The sanctity of the product in terms of features and objective must stand in both bull and bear cycles. We will not change that. We may have short term underperformance as we did about 15 months back, but it has paid off now.
The floating rate fund and the liquid fund?
The floating rate fund is a new fund for us as we launched it only in September 2004. In this category, we are focusing the fund's core competence: buying assets which do not have a lot of interest rate risk. The objective here is to beat the liquid fund returns, without taking too much price risk on the portfolio. We have stuck to that. We have loosely divided the portfolio into two parts. In the first part, we have bought assets purely with the intention of good accrual income on the portfolio. In the second part, we try to spot trading opportunities in five-year or three-year floaters. Here the objective is to generate that extra capital gain, either by trading the market or finding value or by taking a view that spreads on floaters could compress or widen.
The liquid fund is the largest fund category. When yields on corporate deposits and treasury bills were very low, we were quick enough to latch on to the bank fixed deposit market. It gave us meaningful deployment without adding to our credit risk considering that banks in India are very safe. We have a robust internal screening system, which has helped us avoid buying the wrong assets so far. We use that to buy banking fixed deposits. Of course, now there is a bit of a question mark on whether fixed deposits will be allowed and to what extent. We are fighting on that front; we have also changed our strategy internally and are focusing more on securitisation assets. We are matching high yielding securitised assets with cash so that the liquidity risk is taken care of. We have had good performance in the liquid fund in the last 15 months. In November 2003, the corpus was about Rs 600 crore and today it is 2,500 crore and add the floating rate fund corpus of Rs 700 crore and these two funds are together at Rs 3,200 crore.
There were few floating rate securities two years ago. Is there supply now?
Yes. There are enough floating rate securities in the market, especially from corporates as buyers of debt products demand floating rate bonds. I would estimate that corporates must have issued over Rs 10,000 crore of floating rate bonds in the past two years.
Yes, I manage two MIPs. Principal MIP Plus is the aggressive MIP, which can go up to 25 per cent in equities, but we have never crossed the 20 per cent mark. Principal MIP, our first MIP which is the conservative one has an equity cap of 15 per cent, and we have rarely had more than 10 per cent equity in it. The reason we never do that is because we do not want to dilute the objective. The conservative fund has a corpus of Rs 230 crore and investors have given us the money expecting that we will honour the positioning of the portfolio. In MIP Plus, we can be more aggressive in terms of overall allocation to stocks and in stock selection. We have done that and the fund is doing well.
What is your advice to investors?
I always advise investors not to behave in a knee-jerk fashion. Frankly speaking, the best way to make the most money is to buy asset classes when they are not doing well.
Then one should be buying income funds now…
I guess so. When yields touched 7.25 per cent, we went to a lot of investors and told them that the risk-reward was loaded in favour of the investors after a long time.
We had sensitivity analysis done on our portfolios to show that even if yields went up by 50-70 basis points, the carry yield was so good that investors would still have made a decent sum of money. Sadly, we didn't see too many people buying.
What is the role of government savings in an investor's fixed income portfolio?
We tell investors not to shift completely from all other forms of savings to mutual funds or vice versa. We always ask them to maintain a balance depending upon their life cycle, financial needs and the purpose of saving. The only thing I would like to tell investors about mutual funds is that they are market instruments and they get benchmarked to market yields. Therefore, many a times you will see losses on your investments. But remember the loss will crystallise only if you cash out. If you have bought for a longer period, just tide through the bad market performance or bad fund manager performance. Investors should also not necessarily jump in to buy after a great performance.