The Mutual Fund Show: Is This A Good Time To Invest In Debt Funds?

LAKSHMI IYER: Firstly, the RBI did one of the most sensible things it could by actually advancing the policy decision by almost a week towards the end of March because the ailing bond market would not really have had much of support. It looks like, given the Covid situation across the world, there have been coordinated efforts made by central bankers.

We also have seen a slew of measures, but I think the most important measure to my mind is the targeted long-term repo operations, which is much needed, I would say, Bhramastra for this kind of market, which is under an almost complete lockdown, where factories are shut, manufacturing is happening in parts. So, apart from the rate cuts which are definitely good factors for lowering lending rates and bringing about liquidity via CRR cut, lending to the corporate sector, which has been facilitated by the Reserve Bank of India, is to my mind one of the most important measures taken by it and we only wish and hope if these measures prove insufficient, the central bankers will act more swiftly to introduce many more such measures.

LAKSHMI IYER: No, certainly the banking system is flush with liquidity. If that were to be the case, why should banks offer a higher rate of interest given the fact that they are the magnets right now, which are actually attracting a lot of monies in the form of savings account and term deposits? Hence, we believe that given the way the bond markets are perched right now, fixed income strategies of varying maturities to suit an investor requirement, whether it’s a seven-day strategy or maybe a one month, three months, one year as the case may be, we believe that this is one of the best opportunities to consider investments into fixed income strategies.

Just one caveat here, unlike deposits where investors are used to hearing this rate of interest as a fixed one, there is nothing fixed like a rate of interest or return which is guaranteed in mutual funds. If you keep that in mind and you invest with your investment horizon, I think the potentials of unlocking gains in this category are enough and more.

LAKSHMI IYER: See what you’re saying is definitely a probability over a span of three years. But is it a live case or a concern which is going to brew in like today, tomorrow or over the next four to six weeks? The answer is no. Or for that matter over the next four to six quarters, the answer again is no. In the world over, there has been the complete destruction of demand across segments. Barring maybe some FMCG items, discretionary spending is really down. So given that we are not very sure about how high can inflation go, it looks like the inflation numbers that we saw in India in the last couple of months seem to be the absolute peak for now. It may not crash-land in a big hurry because of the supply chain disruption, some price points of certain items have gone up. However, let’s not forget crude oil prices, our biggest import product, is actually on its way lower. So, therefore, I don’t think investors need to be overly concerned.

Over a block of three years, we believe portfolios, which are skewed towards the short end, will re-price itself at least two or three times in a block of three years. So the reinvestment risk, which investors would be worried about if interest rates were to go up, gets taken care of when you are positioned in short fund strategies.

LAKSHMI IYER: So, there are two parts to your question and therefore I’ll answer in two parts. Given the surplus liquidity in the system and the need of the hour to maintain this liquidity, clearly, schemes in fixed income which are having maturities in the portfolio in the range of the lower-end of six months to upper-end of maybe two-and-a-half to three years (that would include the typical ultra-short-term funds, short term funds), yes, like you observed the banking and PSU funds, etc. would be the best option in this kind of a market scenario.

The second part is that given what is happening on the medical side, at this point in time and obviously, we do not have quick solutions, there seems to be a natural slide quality. Therefore, categories that have an orientation in their portfolios with high-grade instruments. When I say high grade, I don’t necessarily mean triple-A-rated instruments. But yes, it’s a combination of triple-A-rated instruments and maybe some high rated conglomerates or public sector enterprises which are high on the Government of India holding.

I think it is a cluster of these categories, which we are observing in the last fortnight or so that investors are taking a fancy to. That’s been our theses. Also, don’t try to go away significantly from the trend. This seems to be a fair opportunity where the ease on an absolute level and relative levels are looking extremely attractive, but if you stay the course (interest rate volatilities can be there, no doubt; but if you stay the course) there is no way that you cannot realise the true potential of that particular category.

AMIT BIVALKAR: I think this is not a crisis in financial markets, but this is a crisis of confidence and anybody who is in debt funds has seen volatility come his way, which was not a recent phenomenon. For us clearly, if you try to look at people who want to put in money in debt, I think this gives a great opportunity.

As Lakshmi mentioned, you have great yields on the banking PSU funds, you have great deals on the corporate debt fund side... I think staying in liquid or overnight will make the trick. You need to go and put money into funds which are between two-and-a-half to three-and-a-half years of maturity.

This point of time I think the market is looking for a lower cost of money and availability of money. The availability of money was their cost of money has come down. So, you will see a lot of people but the gap between haves and have-nots on the corporate space is going up. So, people who will need the money more critically and who are leveraged will not be getting money and therefore it is the right call to be in highly rated corporate bonds or PSUs. I think we are suggesting people get into high corporate debt or probably into banking PSU funds.

AMIT BIVALKAR: I think the effect of the lockdown will be visible only in the June print. What we see is that if you have to go by the rate cut on the small saving scheme, it’s because if you have a higher rate there, then most of the assets will go and lock themselves for 10-15 years in such kind of schemes.

So the government wants to reduce it and that is a clear cut signal that the rates are going to come down. When you are going to see rates coming down, then obviously you need to be in an open-ended fund, which will be between two-and-a-half, three years, so that you will get that capital gain also on your side. People are more asking for a better option and people have learned about FOMO- “Fear Of Missing Out,” but I think it is FOBO which is “Fear Of Better Option”. People clearly are asking about where they should invest their money in debt. I think this is a good time for advisors also to have that asset allocation in place, wherein you can get that debt money into low duration up to banking, PSU or corporate debt funds.

LAKSHMI IYER: Human beings are used to being in quarantine only in the last two or three weeks specifically in India or the world over. If you look at mutual fund portfolios on the fixed income side, they have been already in quarantine mode ever since SEBI actually announced the classification of the categorisation of schemes. So, therefore what I mean by that is that the risk-taking ability of every scheme differs- whether it is interest rate risk or the credit risk, most of the episodes that we have seen in the past 12-15 months are restricted to a few schemes (within that they are restricted to not more than towards mutual funds). So, what the investor is trying to be here is like, ‘Begani Shadi Meh Abdullah Deewana,’ what he or she is trying to do is paint the entire canvas with the same brush.

We are of the view that the bulk of that pain point is behind us. Of course, Covid-related will have its own challenges, which is why these quarantine portfolios which is sticking to the investment mandate based on a particular credit profile or an interest rate profile, which is on the duration side works well in this manner. Therefore, I urge every investor and I tweeted about that this morning also that if you are going to follow the course of your investments, you cannot invest for three years and look at your NAV in three days. That doesn’t really ergo well. You’re best off being in a bank deposit. Last but not the least you have to listen to your adviser because in this market everyone is becoming wiser and sharper and WhatsApp is becoming their adviser. So if you do not succumb to these two mentalities, I think the past is reasonably behind us. The immediate future might be looking a bit tepid, but it is certainly not with appropriateness.

AMIT BIVALKAR: So I think you need to differentiate between leveraged companies there. I think many of the biggies also they do not have the capital to run their companies, I would just draw this to say posy the paper tantrums and the global financial crisis.

Even then you had seen that the short duration had gone to 1,140, your corporate bonds had gone up to 1,050, your 10-year government securities had gone up pretty high, and post six months after the crisis- in three years’ time, everybody actually got a positive experience out of debt funds.

So if you do a deposit in a cooperative bank, you’re not going to look at the NAV on a daily basis. But if you put money in a debt fund as Lakshmi said, you’re going to see the NAV on a daily basis. On WhatsApp, you’re going to see okay, this one lost so much in one day, negative returns in liquid funds, all of that. The risk today is that suppose there are some commodity companies in your portfolio that are getting impacted, for example, oil, then should you be aware of those companies in the portfolio? I think the answer is yes. So the risk today is that the gap between the haves and the have-nots is going to go up in terms of corporates. And companies who are leveraged too much, I think those companies, you might see some downgrade or rating action from the credit rating agencies.

You may not face a loss of capital, but you will have mark-to-market impact which might unnerve you. So if you want to not look at such kind of volatility, then you have to just stop looking at your debt fund portfolio for the next six months. If you’re a three-year investor, I think that you should come out winning on this as well. The only thing is you can’t find the bottom in equity, this also is a pit- which is a bottomless pit because of illiquidity of the market. You might have yields that can just spike up in a day or two because of illiquidity.

Even now, as we speak, Lakshmi can probably vouch for it, that there are corporates who need to run their companies or have some commitments and pay towards it. You will, in fact, see in April, even your liquid funds there will be redemptions from corporates because they want to utilise that money into their own companies. So stay healthy for your own sake in Covid, and stay healthy in terms of your portfolio by looking at the quality of companies you buy. For that reason, I think you need an adviser who can probably do well, well on the portfolios of mutual funds.

AMIT BIVALKAR: So, most importantly, even if your indexation is at 3 or 4 percent and you are putting money, suppose in a fixed deposit at 7 percent and in a debt fund, which in three years suppose gives you a return of 7 percent, what typically happens is on a fixed deposit, you will pay that 42 percent tax if you are in the highest tax bracket or 35 percent or 25 percent. While here, you will get a straight deduction of 3-4 percent of your indexation.

So, seven minus four, you are left with 3 percent which is subject to tax. On that, you pay a 20 percent capital gain which means effectively you pay 0.6. So, if you have got 7 percent pre-tax in a mutual fund, you will get probably 620 to 640 post-tax after indexation with whatever index values will come in the next three years. If you invest that 7 percent fixed deposit, then on that at 35 percent, you are going to pay a 2 percent income tax for sure for that year. Here, the tax also comes into play, whenever you redeem, it’s not like TDS wherein every year you need to deduct tax and pay to the government.

So here the tax and the taxation is on my end, wherein whenever I redeem, I can actually pay tax in that year. Secondly, and most importantly, if we do a systematic withdrawal plan into any of these debt funds, the tax impact, if you redeem only the appreciation from such debt funds, I think the tax impact goes down to 2 to 3 percent. So if you are living off the interest of a fixed deposit, you do a systematic withdrawal plan in a debt fund, your taxation actually will fall to 2 to 3 percent. I think nobody offers this and this is a brilliant feature of the debt product. Definitely, with indexation, you are actually earning one and a half percent to 2 percent better post-tax return than a fixed deposit. Therefore, if you are a high net worth individual you need to come into debt funds rather than stay in fixed deposits.

LAKSHMI IYER: Yeah, first without a doubt. If equity acts as carbohydrates or carbs on your portfolio, which are the energy boosters, I would say fixed incomes are the protein booster for your portfolio. (inaudible)

AMIT BIVALKAR: Yeah, I think what I feel is that equity is your pain killer and debt is your vitamins. So even if you’re investing for five years, or 10 years, you are getting good yields on the five-year G-Sec, as well as you’re getting good yields on the 10-year G-Sec. So if you want to invest, you can straight for 10 years go into a G-Sec fund, you have the predictability of returns, and you can actually stay put there, you will still beat your fixed deposit by 2 percent on a year-on-year basis for a long period of time.

Mind you if you’re getting 2 percent extra from debt product over your fixed deposit, that 2 percent is the alpha that you want to create on your portfolio. I think that becomes a very powerful tool in your hand that you need to look at debt for long periods of time because asset allocation- even if you retire, you’re going to only increase your portion of the debt in your portfolio. So if you’re going to keep that 25-30 percent debt today and gradually as you retire, you make it 40, 50-60 percent. I think buying into long-term bonds, like some of the long-term funds, where you actually buy a 10-year constant maturity kind of product, you buy a 10-year G-Sec and just forget about it. I think that over the long term also will give you definitely that additional extra rather than your fixed deposit.

LAKSHMI IYER: Pretty much similar to what I was saying that if equities are like carbohydrates on your diet, energy booster, fixed income is your protein boosters, and anyways, Vitamin G or Gold is in abundance in every portfolio. So treat it like an asset allocation platter where you need to have the right mix depending on your risk appetite. This is clearly not the time to shun away or shy away from fixed income. Risk-adjusted returns time and again have delivered these kinds of returns. You just need to keep the faith and more importantly, you need to have loads of patience.