The Mutual Fund Show: Here’s The Case For Debt Funds When Equities Are Rising
‘Piggy banks’ sit in a plastic bag. (Photographer: Billy H.C. Kwok/Bloomberg)

The Mutual Fund Show: Here’s The Case For Debt Funds When Equities Are Rising

When equities are rising and concerns persist about corporate debt held by mutual funds, can banking and public sector unit debt funds offer a safer option?

While interest rates may have bottomed out, one needs to understand that they’re cyclical in nature and having an investment in debt is essential to claim the benefits of asset allocation, Mahendra Kumar Jajoo, chief investment officer of fixed income at Mirae Asset Investment Managers India Pvt., said on this week’s The Mutual Fund Show.

The asset manager launched the new fund offer for its latest banking and public sector undertaking bond fund, Mirae Asset Banking & PSU Bond Fund. The fund would invest at least 80% of its corpus in securities issued by commercial banks, public sector undertakings, public financial institutions and municipalities.

It's suitable for those with an investment horizon of at least three years, according to Swarup Mohanty, the company’s chief executive officer.

Sunil Jhaveri, founder of MisterBond Pvt., said investors must have debt funds in their portfolios with a long-term view. He expects a lot of money to flow into the debt market soon as equity markets have become expensive within four months and when the correction takes place, investors will rush back to debt as a “flight to safety”.

According to Jhaveri, this may be a good time to invest in such funds. “The unfortunate part is investors think that money can be made only out of equity as an asset class, but they forget the consolidation phases,” he said. “During these phases, if you’re not being right in asset allocation which includes debt as a category, then you will tend to lose out and you will not tend to make returns on an ongoing basis.”

Watch the full Mutual Fund Show here:

Here are the edited excerpts from the interview:

Swarup, why the timing of this fund (Mirae Asset Banking & PSU Debt Fund) at this current point of time?

Mohanty: I don’t think it has got anything to do with the timing. We got an approval, we launched a fund and then the journey of the fund—the quicker we start it, the NAV comes out faster. Our business is to launch funds and build strong track records. So the timing is immaterial. I mean in the long run, the story of a fund really unfolds and we’d like to concentrate on that part. Bank and PSU funds definitely will be a very important launch from our side because we signal our presence in the longer side of the debt business and we’ve had a good run with the dynamic bond fund so far. So, we’ve built some credentials to that and thanks to Mr. Jajoo for steering that as well. Now, we launch into a category which we believe matches this profile of the Indian investor. It’s a great category to be in and we’ll start our journey as soon as possible. We end the NFO on the 20th, after five days the NAV starts.

Mr. Jajoo, would you want to add to this as well?

Jajoo: Well, like Swarup said, the timing for a long-term investor isn’t a relevant factor. But yes, because of the series of defaults that we’ve seen in the last one and a half years, the banking and PSU has become a very popular category because of the flight to safety. In our fund, as per SEBI guidelines, a minimum of an 80% has to be invested in the banking and PSU papers. But just to maximise the safety from a credit perspective, what we are proposing is that in our fund, even within that 20% flexibility that the fund manager has, he will only invest in the banking and PSU category preferred, or maybe he will invest in the government bonds. So, this fund will therefore provide the maximum possible highest credit rating that is possible to be created in this current market environment. So, it will be a very safe category and it happens to be a very well timed too. We haven’t planned it that way, it’s just that we got the approval to launch it now.

What kinds of returns can an investor expect?

Jajoo: That is always a dilemma for a debt fund manager because SEBI doesn’t allow us to talk about the returns. But at a general level, if you look at the long terms of debt funds, they have given somewhere between 7.5 and 8% on average. And I don’t think that, that pattern will change because we have seen different cycles on the interest rates and we have done some analysis where we took the start date as Oct. 16, 2003 which happens to be the day when our 10-year benchmark government bond yield was at a life low. From there to the next 17 years as of today, a typical bond fund has given a return of something around 8%, give or take up to a few basis points. So I think the fact that a lot of people think that the interest rate might have already bottomed out after the Reserve Bank security action over the last three months or generally over the last one and a half years, I think that the interest rates are cyclical in nature and therefore the way to go about the interest rates to have a flexible interest rate management policy. The interest rate environment changes tomorrow and then interest rates go up, then you bring down the duration and so on. So I think independent of where we are today in terms of the interest rate cycle, I think the historical pattern is what one should expect to be repeated even over the next three to five years.

Sunil, what’s your sense about this particular category (PSU debt)?

Jhaveri: I’m in totally in sync with Mahendra and Swarup for this particular category of debt fund and timing according to me is an extremely crucial part of this debt fund, though they may not have timed it as Swarup rightly said. The timing is important because right now the overnight fund, the ultra-short term bond fund etc. are generating 2.5-3% returns, so nobody wishes to go there. The credit risk space, it’s a recent history where nobody wants to be there. Corporate bond funds have some kind of AA-rated paper, so again there is a question mark there. So, the nomenclature and the sheer credit space of this particular scheme is ideal at the current situation where I expect that there will be a lot of money flowing into the debt markets now with the equity markets having become extremely expensive once more within a span of four months from March 23 to currently where we. Though everybody knows it’s a liquidity-driven market, but as and when the corrections happen people will again rush back towards the debt category and this will be a category which can capture that flows also. So, from a timing perspective, from a credit risk perspective, from a liquidity perspective-- all three perspectives, I think this is a very ideal solution which Mirae is bringing on the table.

Swarup, what kind of investors should target your product and what are the risks according to you?

Mohanty: First of all, I would look at suitable for investors who invest for three years and above and that is the taxation law of India anyway. We’ve seen interests from retail to HNI to institutions in this category, and the fact remains that the category was just a Rs 40,000-crore category one year back, and is now almost lakh of crores. So that shows the interest of people in this category. The comforting factor which I like about this entire category is the risk profile. It’s a well-balanced risk profile, though one must look out for the 20% of non-bank and PSU and that’s where I’d like Mr. Jajoo to reflect on the portfolio strategy. It’s a risk-mitigated category from the Indian debt investors perspective and investors who have the appetite or the horizon for investments above three years are suitable for this category. When you look at investing in debt, unlike equity, the allocation is yet to unfold. I mean, there is a reason that every category is different from a risk-profile perspective. I would sincerely request all investors to categorise the different categories in debt also as per the risk profile and invest accordingly and that till now, the data says has not happened. And we’ve seen suddenly the corporate bond fund, gilt fund and bank and PSU being in vogue. I think some amount of differentiation of risk profiles of each category should be put in place and allocation made accordingly.

Mr. Jajoo, Swarup mentioned about you detailing out the strategy. I think you briefly alluded to what other 20% could also have, but can you elaborate a bit on that? Would it veer towards super safety or would it veer towards taking some bit of risk in order to try and maximise return in that 20%?

Jajoo: When the investors are looking at debt funds, and especially when you’re looking at the banking and PSU category, their primary objective is the safety and there is no compromise. As I said, we will try to provide the maximum possible rating and safety in terms of the credit. So therefore we will, out of that 20% flexibility that SEBI guidelines provide, we stick to the highest quality paper in the banking PSU and the government bond space. Now as far as the returns are concerned, our core value system or thought process is that market risk is temporary and credit risk is permanent. So, if you happen to meet with one credit accident and that we have seen in the last couple of years, then it can upset all your return calculations because essentially at the core of the money lending, is that your money should come back on time otherwise all your return calculations are invalidated. It would rather accept a bit of volatility because of the interest is going up and down because if one has adequate investment horizon and with a little bit of patience with volatility, then the investor is likely to come out with a decent outcome. So I think the return is not a concern with us. The prime objective is to avoid credit situation. And as we have seen in case of the dynamic bond fund that we launched a year ago, the returns have been pretty okay because there is so much volatility in the interest rates. And I mentioned about our flexible investment strategies. So it’s all about being able to manage the interest rates because the returns will come. That’s what we believe. And I think there is enough thought now that the gilt funds or the bond funds have given such a fantastic return whereas the credit risk funds have had their own difficult times in the last couple of years. So,the investors need not worry about the return as long as they’re okay with a bit of volatility on account of the interest rates moving up and down.

Sunil, is this a good time for investors to invest is such a fund? Not just in Mirae NFO but funds in this category.

Jhaveri: What I’d like to position this category is that when you’re investing in your portfolio, there is something what we call asset allocation. Let this be a core portfolio under that asset allocation in the debt segment. The unfortunate part is investors think that money can be made only out of equity as an asset class, but they forget that consolidation phases—there are many consolidation phases which happened in India also. 1992 to 2000 to equities delivered 0% or 2% return, in gold from 1990 to 15 years thereafter there was absolutely no return. Something similar happened in the U.S. markets from 2000 almost till 2012. So during these consolidation phases, if you are not being right in your asset allocation which includes debt as a category, then you will tend to lose out and you will not tend to make returns on an ongoing basis. So ideally, in the asset allocation strategy, make this your core portfolio so you don’t have to bother about your credit space, you don’t have to bother about your liquidity space, and let the fund managers find the sweet spots which Mahendra will do a fantastic job in I’m sure of that, between two years to five years is what they are going to do. And based on that, they will deliver it because it’s not a question of just one cycle or two cycles; let this be a multi cycle investment.

Sunil, what other options are there aside of this NFO in the same category?

Jhaveri: In the debt category, I don’t see many options available right now. If you have the appetite for credit space, go to the credit space. It has a lot of opportunities there by the way but having burnt fingers, I would not recommend for those who don’t understand credit to go there at all. Liquid fund and the ultra-short term as I said is giving you sub-fixed deposit return so why would you go there? This category and there are different types of investment strategy—one of the schemes has a 10 year roll-down strategy, Mahendra is going to manage dynamically between two to five years and so on and so forth. So this category according to me will stay for a long period of time.

And Swarup?

Mohanty: It’s a brilliant category and very well suited for risk averseness as well as giving the upside in the market. And please make it the core portfolio, whether us or anybody, but as a category, and then build your satellite as per your risk-taking ability. Like on the equity side, you build it on the large-cap of the multi-cap. This is that counterpart on the debt side and it’s poised to be a good run for the next three-five years and some people who are saying that we are a low interest rate regime, Mr. Jajoo will agree with you and we’ll talk after three years.

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