Pru-ICICI Income Plan's Fund Manager, Sanjay Garodia on his Investment Strategy

"The huge benefit of running a large debt fund is- sourcing of bonds directly from the issuers and better cash management."

Prudential-ICICI Income Plan has emerged as the biggest open-end bond fund in the Indian fund industry, in less than three years since launch. With assets under management at nearly Rs 2300 crore, the fund has delivered an impressive return of 12.79% since launch. Managing a large sized bond fund is normally perceived to be a tough task, especially considering the illiquid Indian debt markets. Yet, fund manager Sanjay Garodia believes that there a number of advantages, which come with a large income fund.

Q.Over time, Prudential Income (PIIF) has emerged to be the largest sized open-end debt fund. What are the benefits and problems faced in managing a large debt fund?
SG:There is a huge benefit in having a large debt fund. The primary advantage is in terms of sourcing of bonds. Having large fund results in dis-intermediation in a large way, i.e. number of issuers' come directly to us and hence we get better rates in investment of assets. The size also results in more information sharing by the intermediaries and brokers. Size enables us to pick up large ticket deals, which otherwise would go to a trader who in turn down sells at a profit. Having a large fund enables better cash management. The total amount in cash and call can be brought down to a smaller percentage of total assets. It has helped us to launch lot of retail friendly services like Insta-Cheque. Till date, we have not faced any problem in managing the income fund because of size.

Q. The expenses of the fund have not come down in line with the rising corpus. The economies of scale that one expects to see with a large sized debt fund are yet to be reflected in PIIF. Your comments.
SG: The expenses of the fund have come down between March 1999 (1.75%) and March 2000 (1.67%). However, since PIIF is a no-load fund (no entry load), the brokerage and trail commission is paid out of total expenses. Unfortunately, some of the costs like the intermediation/distribution costs are variable and driven by market dynamics. However, the investor benefits on account of better risk adjusted returns, due to our ability to source better deals.

Q. What is the internal limit on exposure to gilts and portfolio maturity?
SG: The internal limit is that of liquidity. The limit to gilts is about one third of total assets. Till date, exposure to gilts has not exceeded more than 30% of the corpus. The rest of the assets are invested in corporate debt and short term securities. The exposure to gilts is more of a mechanism for portfolio duration management. The average maturity of the corporate paper is significantly lower than that of the total portfolio. The internal limit on portfolio maturity is normally 4 years, but in times of extremely positive outlook, we have an option to refer it to the investment committee for an extension.

In recent times however, we have not exceeded the portfolio maturity of 3.9 years. The product is positioned as a moderate risk fund. The maturity of the Prudential Gilt Fund, for example, is over 7.5 years as that is positioned as an aggressive debt fund. There are additional limits in terms of single company exposure in the fund. Till date, the exposure has not exceeded 8% in a single company.

Q. What has been the reason behind the marginal exposure to below triple AAA and un-rated instruments? Do they give a kicker to returns with an above average coupon?
SG: Credit rating plays an important role in purchase of securities and we have a research process, which evaluates each company, before we invest in it. The companies we have invested in and are unrated have been thoroughly researched before investing. The approval process has involved taking approval of the board even before SEBI guidelines came in. If you were to look at the companies we have exposure to, they are either strong MNC names with parent guarantees or companies which have a dual rating in the market and these specific instruments were unrated. The same applies to companies below AAA ratings. The companies we have exposure to, have a strong parentage, financials and are rated below AAA because of either the industry cycle they are operating in or are operating in a single business and credit rating agencies do not usually give AAA rating. While safety is paramount to us, the companies we have exposure to are extremely credit worthy in our view. And rating of AA is supposed to be a very good rating if you look at it in the international context.

Q. The Fund witnessed large redemption in March and August last year. What is your institutional base? Does that bring instability to the fund?
SG: There has been a difference in assets under management between July and August last year of about 8.3%. This to our mind has happened because of two reasons.
a) The debt market was volatile on account of rupee and rate hikes, hence we did not witness any fresh flows (no new money was coming in) and b) the redemption was slightly more than normal on account of the prevailing sentiment. The case was similar for the period between February and March since due to year-end sentiment, there was profit booking and hence the withdrawal on that count.
We have a three-month load in the fund, which we have not removed at any point in time since the inception of the fund. It is designed to discourage short-term money and thus, the fund remains stable at all points in time.

Q What is your investment strategy and interest rate outlook?
SG: Given the recent announcements by the RBI and the bold steps taken in the budget to bring about a structural change in interest rates, our view is positive on the debt markets. March can be bit of a dampener on account of profit booking by banks and primary dealers. But the outlook is positive going into next year. We plan to cut the portfolio maturity slightly and rebuild it towards end of the month. There has been a lot of supply of corporate/ PSU paper in the last couple of months. This has resulted in the spreads widening to about 100-110 basis points against the normal spread of 90-100 basis points.

We believe there has been an increase of liquidity premium rather than corporate versus government securities. Even in case of gilts, there is a huge difference in yields. For example, the difference in yields between 11.30% GOI 2010 and 12.32% GOI 2011, where there is a difference of six months in maturity, there is a spread of up to 60 basis points. Therefore the spreads have widened if you look at liquid securities but have remained there if you look at the illiquid gilts. In our view now, that the events (bank rate cut, saving rate cut etc) have happened, the market will look at the anomalies and the spread correction should happen by April.

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