'Don't get adventurous with debt funds if your aim is to preserve money'
We spoke to Lakshmi Iyer, CIO (Debt) & Head of Products at Kotak Mahindra AMC on a number of topics ranging from interest rate hikes to debt fund portfolios and returns
Sep 21, 2018
About a year ago, fixed-income investors were dealing with an interest-rate cut by the RBI and expecting more to follow. Twelve months have passed, and now the debt market is grappling with two successive interest-rate hikes by the central bank.
Like the future, interest rates are proving to be difficult to predict. That being the case, retail investors approaching debt funds can still keep it straight and simple, says Lakshmi Iyer, CIO (Debt) & Head of Products at Kotak Mahindra AMC.
In an interview with Kumar Shankar Roy, the money manager, who manages more than Rs80,000 crore, talks about how she has seen over time that a combination of short, credit and medium funds meet more than 90-95 per cent of fixed-income requirements. Her candid advice is if your primary objective from fixed income is to preserve and stabilise your money, then there is no point in going for undue adventures.
The RBI has hiked interest rates for the second time in about two months. Will this further reduce long- and medium-duration debt-fund returns?
My sense is given that interest rates are already at an elevated level. The incremental change from here can only be data-dependent. But because there is uncertainty, we have been suggesting that investors stick to a combination of short- and medium-term funds. So, at this point in time, it is better to wait and watch before getting into long-duration gilt or bond funds.
Why are you recommending short- and medium-term funds?
There are chiefly two reasons. One is that even if there is a rally or a potential for capital gains, that can be captured with a relatively lower duration as well (though not as much as with long-duration funds). The second thing is that since these categories are inherently low on duration, they reduce volatility to a large extent. Investors can stay put in these kinds of funds because of lower volatility and higher yield to maturity in the portfolios.
Are more rate hikes possible in the next 12-15 months? Why?
I am not ruling it out completely. There could be a pause in October, assuming the data remain where they are. If you look at BRICS nations, India is the only one hiking rates. The RBI's stance is also neutral. Data globally and locally are suggesting that India can afford a pause at this time. But over the 12-15 months if the economy continues on its growth path, the world's central bankers will have to tighten and India will not be an exception.
Is RBI's stance really neutral? It has already hiked rates two times...
In August 2017, we saw a rate cut when RBI was neutral and that's when we moved from 'accommodative' stance to 'neutral'. Accommodative means the scope for rate cuts is higher. We are not in a tightening mode. The RBI has stuck to a middle path and hence is neutral. It signifies today's conditions may warrant any rate action but one needs to evaluate the data points and then take a decision. Think of it like a car in the neutral gear, where the engine is not switched off.
Are short-duration funds better placed today in terms of returns and volatility?
Any day they are better placed. I would go as far as to say they are the best placed in terms of return profile and volatility matrix. I would even include the credit-risk funds in the same bandwidth. A combination of short- and credit-risk funds would hold well for investors. These products are well-poised to ride the interest-rate movement journey in the next 24-36 months for any fixed-income investor who wants a little bit of duration and does not want roller-coaster volatility. Let me give you an example. Despite interest rates moving higher by about 1.5 per cent in the past 12 months, these funds have shown the potential to outperform traditional modes of investment over a three-year horizon.
Between FMPs and credit funds, which make better sense today, now that duration is not paying off?
FMPs will give you a higher certainty because as a fund manager I am locking in assets to the maturity of the FMP, thereby mitigating interest-rate risk. Therefore, if you want certainty, definitely go for FMPs. But if you want to keep your upside open, it should be an open-ended fund strategy, whereby you take a combination of credit-risk funds and/or short-term bond funds. The biggest advantage is that the investor will have liquidity available and can exit at a short notice. Open-end funds are worth your consideration at this juncture of elevated interest rates if you can compromise a little bit on the certainty element.
Are you increasing allocation to AA and A-rated companies? How do you approach investment in companies rated BBB or lower?
It depends on which strategy we are running. In credit-risk funds, we look at a combination of AA and A rated assets. In funds where we focus on credit quality, we look to diversify and consider AAA rated private-sector bonds. These bonds could offer a better yield than a private-sector bond of similar maturity. We make such tweaks depending on the fund mandate. We are also conscious of not extending the duration at the current juncture.
Usually, we don't invest in BBB rated bonds. The overall risk parameters, along with the security cover, govern the underlying investment. This is why even in our non-AAA rated investments, you will hardly find a bond that is non-collaterised.
The macros are changing every day and so are the issuers' businesses. Our threshold is A to A minus. Even in that, the exposure is very tail-ended and is about 10-15 per cent of the total portfolio where we undertake credit risk.
Some credit-risk funds have high exit loads of 3-4 per cent, but your fund is among the ones that have 1 per cent load. What is the explanation for this divergence?
The credit market, in general, is less liquid. But over the last many years of our existence, we have kept 25-30 per cent of our portfolio in the basket with tenure of one year or less. These are the most liquid assets available for trade in the secondary market today on the credit side. Therefore, we have had the luxury of maintaining an exit load of 1 per cent.
Investors don't understand bond markets much and if we keep a high deterrent in form of steep exit loads, that may not help. We have to keep it amenable, but at the same time not compromise on the risk. That is why we have consciously chosen to remain liquid at the shorter end.
Gilt funds with 10-year constant duration have done well from a three-year perspective. Should investors go for these gilt funds now or wait for better times?
If somebody wants to take exposure to longer duration and has gilt as part of the portfolio, then he should invest in an actively managed gilt fund. He need not go into constant duration. A normal gilt fund has the potential to move between government securities and has alpha-generating opportunities. So if you are a long-term investor, a well-managed gilt fund could be a better alternative than a constant-duration gilt fund.
Over a cycle, i.e., three to five years, actively managed gilt funds have shown visible results compared to the ones hugging the benchmark or the 10-year yield due to stock rotation.
Equity funds had to do considerable portfolio changes post SEBI's recategorisation. Can you take me through how debt funds have been impacted? Did you have to make changes?
Honestly, the SEBI exercise has cleared the cobwebs in the mind of debt-fund investors and, to a certain extent, the channel partners. Earlier, the market was inundated with strategies of various names. The categorisation has not led to a material alteration in the portfolios of debt funds from an industry perspective. The categorisation has brought about a much-needed clarity.
On the equity side, it was reasonably straightforward, i.e., you have a large cap, mid cap, small cap and combinations thereof. On the debt side, you have duration-based and credit-based buckets. So the categorisation has also brought about standardisation. The industry was following this in bits and pieces earlier, but now everyone has to adhere to the rules.
Which are the debt funds that should be in a retail investor's portfolio and why?
Even if somebody is comfortable with risk or otherwise, a very important thing to know is your investment horizon. You might be a risk-taking investor but you may require to take the money out at a very short notice.
Irrespective of the risk genre an investor falls into, any surplus money should be kept in liquid funds if you have immediate use. Keep liquid funds as the bellwether of your portfolio. Across rate cycles, they are the sure-shot clincher in your strategy. Everything else, i.e., ultra short, short, etc., are small variations. If your liquid allocation is taken care of, then the next thing is a combination of short-tenure funds and credit-risk funds. These two options should be a large portion of your debt-fund portfolio and you should have a minimum three-year horizon from the perspective of tax efficiency.
While we are right now in a situation where interest rates are elevated, there is nothing that prohibits them from going further up after a small pause. Investors who are willing to take tactical bets can choose long-term and gilt funds. Do remember that these are more of cyclical plays. Over time, I have seen that a combination of short, credit and medium category can meet more than 90-95 per cent of your fixed-income requirements. If your primary objective from fixed income is to preserve and stabilise your money, then there is no point in going for undue adventures.