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Interview: Risk Fencing

Ritesh Jain joined Kotak AMC in December 2002. A fund manager on the debt side, he heads a team of four. Here he speaks on interest rates, inflation and structured products.

Ritesh Jain joined Kotak AMC in December 2002. A fund manager on the debt side, he heads a team of four. Here he speaks on interest rates, inflation and structured products.

What are your views on the current inflationary scenario and high interest rates in the country? Does it alarm you? No. I believe the RBI will ensure that inflation is contained within the targeted limit of 5-5.5 per cent. The hike in interest rates and tight liquidity will ensure that the inflation rate will fall within the targeted band. Banks have raised interest rates by 100-150 basis points within the last couple of months when RBI has not touched a single rate except 25 basis points in the credit policy. Banks, in general, are already feeling the pinch.

Retail/housing borrowing is for a three-, five-, 10-, or 20-year maturity. But the banks are borrowing with a short maturity. So, with a one-year deposit on their books, they are funding a 20-year loan which is a serious mismatch. The old fixed deposits that are up for renewal have all the banks vying for it and the one that offers the higher rate wins. This means, on the liability side, the rates go up. To maintain the net interest margin they will have to increase the rate on the asset side too.

In the longer term is it not worrisome?
Certainly. At 10-10.5 per cent, companies having capex plans and households will have second thoughts on borrowing. On the other hand, I believe this is necessary to slow down the economy a little bit. Let's at least create the infrastructure.

What would you recommend for a fixed income investor now? Fixed maturity plans or floating rate funds?
The CP/CD rates for around three months is 10-10.25 per cent and the one-year rate is around 10.5 per cent. FMPs essentially invest in CP/CDs. On an FMP, you can get 10-10.5 per cent with indexation benefits. We last saw these rates in 2000. In the month of February and March, FMPs outdo other funds in collections. That is because of tight liquidity and banks' balance sheet management.

If you want to exit before maturity, you pay a small penalty just like in a fixed deposit. With a bank FD, you are taking a risk on the bank. With an FMP, you are taking a risk on fund manager and his ability to take the right risk.

If you are willing to and invest in March or April and believe that inflation will come down, growth will slow down and money will flow from the credit side of the business to G-Secs, then consider income or bond funds with a one-year horizon since they hold a mix of G-Secs and corporate bonds.

The floating rate benchmark is INBNK which is linked to one-year treasury rates. Because of high SLR demands, the treasury rates are not going up. So if the one-year treasury rate does not go up, then even if you are investing in a floating rate fund, the fund return does not go up. If you need money for the very short-term, then liquid funds are the answer.

Kotak AMC has quite a few structured products. Will more such products come into the market? Yes. The equity markets will not give the same return that they have been giving over the past few years. Structured products give a higher return on the debt side with the equity flavour. Years ago it was only debt. Then came equities, followed by commodities and now structured products. You even have Gold ETFs. Another thing I have noticed is that the SIP culture is taking shape in India. A lot of household savings still have to get channelised into mutual funds.

What was the secret of Kotak Flexi Deposit becoming the second best-performing fund in its category last year?
The fund was initially launched as a dynamic fund that would take calls across the market. So if the market was going up, then move out of cash into the longer end or if the market was going down, then move out of the longer end into cash. Of course, this is easier said than done.

We found out that the difference between one- to six-month paper and six- to 12-month paper was huge. Today, let's say March paper is going at 8 per cent, May-June paper is going at 9 per cent and December paper at 10 per cent. In a liquid fund you would normally sit at the shorter end. In a flexi fund, we decided to do a combination of all three.

So when you have 8+9+10 divided by 3, the yield goes up. We would still be sitting on non-marked-to-market paper like CP and CD in which we actively trade by buying and selling at 5-10 basis points difference. We kept 60-80 per cent of the portfolio constant and traded the balance. This resulted in a higher yield in the portfolio over the past one year.

This is the reason why the return is hugely positive. While we trade in and out quite easily, in a mutual fund dominated market I do not see much trading happening but more of buy-and-hold. So over a point of time, the performance improved dramatically.

Do you actively manage the debt portfolios even in your balanced fund and income fund?

We only take interest rate calls on the pure debt funds. In the hybrid fund, I manage the debt portion which is 30-35 per cent. I normally do not take interest rate calls in this fund and prefer to have a passive debt portfolio.

Where Kotak Income Plus is concerned, the debt portfolio does not have much of a determining factor. The 20 per cent in equity is more on the aggressive side and the determining factor. On the 80 per cent in debt, when interest rates are rising, we did not have too much of marked-to-market component. It was a static portfolio. We would still prefer a carry-yield portfolio and not take trading calls. A few stocks moving in equity would make a big difference, but a few basis points on the debt side would not.

The returns on Kotak Bond Deposit seem volatile. Why?

Like I said, we like to take trading calls restricting our downside. I believe in two things: Manage your risk and listen to the markets.

At various points of time, we decided to cut our risks, which is really not an accepted norm in a mutual fund. If you cut your risk and the market again goes up, you lose money and the fund becomes volatile. But that is how we decided to manage our funds. Volatility will creep into a fund when you trade and take a call to cut 10-20 per cent of the portfolio when it goes below the level at which you decided to exit. But ultimately we are not too concerned about volatility and want to give the best possible risk-adjusted return.

In a falling interest rate environment, it does not matter at all. But in a rising interest rate environment, it is necessary to cut your losses especially when the market is in a trading zone. It is not 14 per cent coming down to 7 per cent, it is 8.4 per cent going to 7.4 per cent and then back to 7.9 per cent and then again going down. In such an environment, you need to have a 20-30 per cent trading portfolio. This is the reason for the volatility. But this fund has performed extremely well.

A year ago the return was 6-7 per cent. If you had invested 80 per cent of the portfolio at 7 per cent, the net result would not be great even if the balance was invested at a high interest rate. Today, 60-70 per cent is going at around 9-9.5 per cent and on the rest 30 per cent you can trade. And if you make the right calls the returns can be quite attractive.

If a fund manager can manage his risk, returns will never be a problem.

What should investors expect now?

Investors should not look at daily returns and should stay invested for at least a year in long-term horizon funds.

Approximately, the returns for long-term bond funds over the next one year could be above 9 per cent. Short-term bond funds can generate around 8-8.5 per cent. Except for the liquid funds, volatility has crept into other debt funds and will be a part of it unless you just buy a CP and CD and sit tight. Today, the market is too dynamic.

Two years back, liquidity meant Rs 30,000 crore going to RBI. Now for 10 days money goes to RBI and for the next 10 days the RBI is providing the money. Ten days ago we were deploying money at 7.5 per cent overnight but today we deployed at 5.90 per cent, a difference of almost 200 basis points. FIIs are taking positions in the G-Sec market. By the time you know why the market has gone up, a player would already have bought Rs 500 crore of G-Secs.

So if the market is going against you, realign your portfolio and reduce the risk component. The market always gives you an opportunity to return.