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Interview: Bond To Perform

Navneet Munot holds a post-graduate degree in accountancy and business statistics and is a rank holder chartered accountant. He is also a CFA charter holder from CFA Institute USA.

Navneet Munot holds a post-graduate degree in accountancy and business statistics and is a rank holder chartered accountant. He is also a CFA charter holder from CFA Institute USA.

Munot joined Birla Global Finance Ltd (BGFL) in 1994 and had been a part of financial services business of the AVB Group since then. Having started as a trader in equity and corporate debentures in BGFL, he worked in different functions. He also worked in Birla Sun Life Securities and handled fixed income research, institutional relationships and proprietary trading. Munot moved to Birla Sun Life AMC in early 2001 as part of the fixed income team before taking over as chief dealer and portfolio manager. Promoted to CIO, fixed income, last year, he also oversees the hybrid funds.

What are your views on the debt market and future expectations?
The debt market has been going through a difficult period mainly due to a secular rise in interest rates. Market volumes are very low and there is a lack of interest among most of the market participants. Currently there is hardly any activity in corporate bonds and structured instruments. Primary dealers of government securities are trying to make money in equities, insurance companies are only buying treasury bills, provident funds are not looking beyond bank deposits and mutual fund investors are only in money market funds. To me, these are classic signs of a market bottoming out. A deep, vibrant bond market is a pre-requisite for sustaining the current growth momentum. I believe that the debt market is likely to witness exponential growth over the next few years. I also expect a lot more interest from foreign players in our debt market as and when regulatory and market structure become more conducive. Looking at either absolute or on a relative basis, nominal and real interest rates are approaching the levels where they would start looking attractive. Higher volumes and volatility will attract trading interest in the market.

Where do you see the interest rates headed now?
The benchmark 10-year yield that touched a low of 5 per cent in 2003 is now trading at 8.30 per cent. While RBI has increased the reverse repo rate by 150 bps over the last two years, the market seems to be ahead of the curve.

Going forward, liquidity will reduce as we move into busy season and government also starts building up surplus. Though the trend of rising rates is unlikely to reverse in a big way, the upside potential is also limited. We believe that long-term inflation expectations would be contained at 4-5 per cent and also looking at rates prevailing in rest of the world, bond yields at 8.5-9 per cent would offer a decent risk premium. We expect RBI to increase repo rate by another 25-50 bps. However, the yield curve is steep. We expect interest rates to peak out on a medium term basis in this quarter.

Tell us about your research team.
We have one of the largest investment teams. On the fixed income side, we have three fund managers including me, three research analysts and a knowledge management executive. We also leverage upon our strength in the equity research where we have three fund managers and six analysts.

What investment style do you follow for your medium-term funds?
We follow a mix of top-down and bottom-down strategies in our bond funds. Top-down strategies are duration call, sector allocation and yield curve positioning while bottom-up strategies are credit analysis, trading and quantitative analysis. Based on our assessment of macro-economic fundamentals, we form an interest rate view and decide on the duration of each fund.

Though bulk of our portfolio is in high-quality instruments, importance of credit risk management cannot be undermined. We constantly look towards getting in companies with potential of credit upgrade while weeding out downgrade candidates. We also take advantage of trading opportunities in all sectors of the bond market. Though we compare our portfolio and returns with those of respective benchmarks, the portfolio is actively managed and will have deviations from the benchmarks. The idea is to generate superior returns through active management and not mimicking the index. We have internal templates for each fund that outlines a broad framework in terms of risk-return profile, asset allocation, duration band etc.

What about the short-term funds and the liquid/ floating rate funds?
As far as the liquid fund is concerned, investment decisions are based on the criteria, strictly in the order of safety, liquidity and returns. The focus is on preservation of capital and at the same time providing reasonable returns in line with the prevailing money market rates on a consistent basis. Birla Cash plus was the first liquid fund in the country and our strategy of keeping the sanity of the product has kept us in good stead even in times of systemic shock. We maintain a balanced portfolio of fixed and floating rate assets without compromising on liquidity. Normally, the average maturity is kept around 0.2 to 0.3 years and exposure to mark-to-market papers is avoided. Credit risk is managed by having a well-diversified portfolio of papers that fulfills our stringent internal norms.

Short-term funds are positioned between liquid and income funds on a risk-return scale and our objective there is to generate relatively higher returns than liquid funds over medium term by assuming some interest rate risk. While we don't take exposure to long-dated G-secs and corporate bonds, we use trading opportunities in a very calibrated manner.

For floating rate funds, our endeavour is to minimise the interest rate risk to the maximum extent possible by investing in floating rate instruments.

The portfolio has an ideal mix of papers benchmarked to yield on G-secs (INBMK) and overnight rate (MIBOR).

While keeping a lid on volatility, all our liquid/short term funds strive to maximise returns through various strategies. We look for relative value on all curves such as treasury bills, swaps and corporate papers. We use trading opportunities in money market instruments and floaters. We also leverage on our strength of rigorous credit appraisal and monitoring by identifying good-quality credits ahead of the market.

What is your strategy with the hybrids, which are in trouble from both sides at the moment?
First and foremost, we adhere to the stated investment objective and maintain the discipline of asset allocation. I did not increase equity exposure to unusually high levels even when equity market outlook was very bullish. In fact, I would say that trouble in both markets offer interesting opportunities for hybrid funds. High short-term rates are providing an opportunity to maintain a good current yield portfolio without assuming too much interest rate risk. A volatile equity market gives opportunity to pick up quality stocks at reasonable valuations.

We have been running a low-duration debt portfolio to generate stable income. We will continue to manage the portfolio on a dynamic basis depending on our views on the market. We also take advantage of opportunities thrown by the derivatives market to enhance returns.

I would also highlight one thing here, our balance funds (Birla Balance and Birla Sun Life 95) are managed on a bottom-up approach. We pick up companies that have sustainable competitive advantage, scalability and visibility of growth and earnings, run by capable and efficient management and available at reasonable valuations.

Your funds have very low average maturities. You have also reduced the average maturity of your medium term fund - Birla Income Plus - substantially in the last few months. This suggests that you are quite conservative. Your views
In an environment of sharp rise in interest rates, the only way to protect downside is to have low duration. Unlike developed markets, our investors are not indexers who would be happy with a fund manager who has beaten the benchmark. So running relatively low-duration is a well thought-out tactical strategy to hedge against interest rate risk and cannot be termed as conservatism or aggression. We used to run high duration when interest rates were on a downward path and we would again be building duration in line with the scheme objective at an appropriate time. Our income funds have generated absolute positive returns over the last three months, a period when the 10-year yield has shot up by almost 100 bps.

Do you think there is any room for debt funds at all in the retail investors' portfolio, given that the government savings schemes are providing reasonable returns under the present circumstances?
Mutual funds offer a variety of products to suit each investor's risk-return profile. Debt funds offer competitive returns compared to other investment avenues with added advantage of liquidity, ease of transaction, convenience and tax benefits. Investors also enjoy benefits of active management and portfolio diversification. Income funds do well during periods of stable to declining interest rates while short-term funds offer better returns in a rising interest rate environment. Retail investors can take advantage of prevailing high short-term rates by investing in accrual products like liquid/short term/floaters/FMPs. We expect long-term funds to generate investor's interest over the next few quarters.

This year's budget has bestowed tax incentives upon bank fixed deposits as well. Is it an another setback to the beleaguered category of income funds?
The tax deduction for five-year fixed deposit will not have much impact on our flows. There have always been competing products like post office savings scheme, ULIP, RBI relief bond, corporate fixed deposits so on and so forth. Despite these products, debt funds have found favour with investors. Income funds have a long track record of delivering superior risk-adjusted returns. Our own Birla Income plus has been in existence for over 11-years and has delivered decent returns over this period. Mutual fund industry has matured with time and has provided attractive options to investors for every market cycle. Lack of interest in income funds is more due to interest rate cycle than anything else as investors have switched to other categories of debt funds. The growth of debt funds is a result of good investment track record and consistent improvement in product features and service standards. I am quite confident that this industry in general and income funds in particular will continue to grow despite competition.