The Mutual Fund Show: Options For Debt Investors After RBI Keeps Rates At Record Low
What options do fixed-income investors have after the RBI's recent monetary policy kept rates at record lows?
Multiple defaults in the last two years had triggered concerns about debt funds. Some of the schemes have lost money in the last six months to a year. What options do fixed-income investors have after the Reserve Bank of India kept rates at record lows even as inflation is expected to rise?
“Most of the money lying in the mutual funds right now is below three years in terms of maturity and even more in less than one year maturity,” Sandeep Bagla, chief executive officer at TRUST Asset Management, said in this week’s The Mutual Fund Show. “So, the investors are sacrificing the yields or returns in search of safety and in search of predictability.”
Credit funds have not really performed in the last three to five years and because of the volatility, investors have shied away from taking exposure to some of the well-performing categories as well, he said.
After the RBI policy supported lower interest rates, any three-year fund has a roll down maturity, he said. The interest rate keeps coming down over time and the scheme offers a high-quality AAA-rated portfolio, according to Bagla.
It’s good to invest in such funds in because instead of favouring the safety net of liquid funds, an investor would get almost 250-300 basis points higher returns in these funds, he said. “And if an investor would hold the fund for three years, one would get tax benefits as well.”
Vishal Doshi, partner, Alpha Investment Managers, however, advised investors to remain at the shorter end of the curve because an uptick in inflation and rates seems imminent. He recommends low-duration banking and PSU funds.
And if there’s money lying in any of the schemes that are running into losses because of a corporate default, Doshi advised investors to take money out. That’s because default exposure is already a segregated portfolio, and when a recovery happens, as in the case of UTI Credit Risk Fund, the investor is anyways going to get that amount, he said. “So, there is no loss for the investor as such by getting out now.”
Watch the full interview here:
Here are the edited excerpts from the interview:
Did the policy do anything to change the outlook or modify it even little bit from a perspective of a debt mutual fund investor?
SANDEEP BAGLA: So, the policy was on expected lines. There was no change in the policy, there was reverse repo at 3.35%, repo at 4% but operational rate as you are aware now is the reverse repo rate. We have a huge borrowing programme to contend with, almost slightly more than 12 lakh crores to borrow for the government. So, the RBI wears the dual hat of an adviser, as a merchant banker and also as a rate setter for controlling inflation and maintaining financial stability. Now, what is very important right now, while the policy was very much on in lines, I think the RBI governor came out largely in support of lower interest rates going forward because he said that RBI is going to support the borrowing programme and buy a lot of government bonds—thereby adding a new dimension of demand which will then counteract against the increased supply in government securities. That is why my guess is that government bond yields ended the day five basis points lower. However, the main thing I think is, what the long-term inflationary outlook is and that is something on which I think the market is fairly divided on and people really don’t have a clue as to what the inflation rates are going to be for the next one year, five years and 10 years. I think that is what matters the most in the longer term. In my experience I have seen that the 10-year yield typically trades about 200 basis points higher than expected inflation. Now in India we do not record the inflation expectations explicitly. So, we don’t have an estimate of what the economists are predicting inflation to be one year from now, two years from now or five years from now. So, it’s very difficult to really judge what the real interest rates are but, in my mind, I think if you look at real interest rates at 10-year yield minus the overnight rates or expected inflation, it comes typically to about 200-250 basis points. Now from a mutual fund investors’ perspective most of the money that is lying in the mutual funds right now is below three years in terms of maturity and even more in less than one year maturity. So, the investors are sacrificing the yields or returns in search of safety and in search of predictability. Now, as you are aware that credit funds have not really performed in the last three to five years, while the low-end bond funds have really given good returns close to 8% or an average for the last three to five years. However, because of the volatility, investors have shied away from taking exposure to those funds. So, I think from an investor’s perspective any three-year kind of a fund which is a roll-down maturity, so the interest rate just keeps coming down over time and is offering at high quality AAA kind of a portfolio, is good because the opportunity cost of that is 3% in liquid funds, you’re getting almost 250-300 basis points higher in those funds. So, I would recommend any roll-down corporate bond fund of less than three years to a three years’ kind of maturity because the interest rate risk is less, and the carry income is quite healthy and if you hold for three years you get tax benefits also.
What’s your sense on an even lower duration? I mean, there is a school of thought which says if indeed we are going to get maybe 6.5-7% on the 10-year sometime later this year. It’s a hypothesis but if you believe that could be the case, then good passive low-duration products be ideal because of the way they would adjust to the rising rates as opposed to a slightly longer duration?
SANDEEP BAGLA: Yes, passive low-duration funds are all right, but the problem is that the shorter end of the curve is very depressed because of the low reverse repo rate and abundant liquidity. So, one can get, very close to 3.5% or at the max 4%. So, then you’re not beating inflation so to say. So, as a placeholder and as a place to just stay invested for better times, probably low-duration funds are all right but in rising interest rate scenarios even the one-year funds will not do very well in terms of protection. So, it depends on your time horizon. I would suggest that depending on your time horizon, match your portfolio maturity and maybe break your fixed income investments into various buckets. So, don’t give up on the long-term bonds also keep 10, 15-20% allocated there because if inflation comes down, there is no way Indian rates will go up irrespective of the supply. So I think inflation is a key to where long term interest rates will be and while we are celebrating the return of the economy, it is still not very clear as the output gaps still very large, there is absolutely no wage inflation. So, there are a number of factors which seem to suggest that the recovery could be short-term in nature as regulators would like to wait and watch rather than act in a hurry. For the last 10-12 years, the business cycles have become very swift and short. So, it is better to keep interest rates low for slightly a longer period. So, lower for longer I think is the key right now and fixed income portfolios should be like that.
Therefore, what are you doing in your AMC currently? If you believe that higher interest rate is not a given, nor is a lower interest rate, what kind of portfolios are you offering? If I am not wrong, you have this set of products which is a mix between active and passive. Can you tell us a bit about that?
SANDEEP BAGLA: So, we have come out with a limited active strategy. What it basically means is that these are somewhere between active and passive. We build a model portfolio from the universe that we select. So, for the initial few offerings of fixed income funds we have tied up with Crisil as our strategic knowledge partner, and Crisil is helping us in the investment process by back testing, by calculating and applying our filters. So, we have come out with a strategy that first we define the model portfolio and the universe that we are going to invest in. So, for example in our banking and PSU debt funds for Trust Mutual Fund’s banking and PSU debt funds, we decided that we will take only exposure in companies which are AAA rated in the long term and we decided that we will not take all AAA’s, we will have a four-filter method which will decide which companies can come potentially into our universe. So, we found that about one-fourth of the companies that were rated AAA came into our portfolio and the calculations were done by Crisil. So, our fund manager only chooses from that refined and curated universe of companies. We want to avoid a situation where a AAA company which is rated very high but turns quickly into a disaster by getting downgraded or even defaulting which happened three years back. So, we feel that in order to provide consistency and to provide a regular income, we need to be very careful in terms of choosing where we invest. There is also a concept of model portfolio with predefined variation limits. Again, we have developed this with the help of Crisil and the fund manager can change the allocation of a certain security or a sector but within predefined limits. So, it is like freedom within a framework or it’s limited active. So, that’s why we call it limited active. At all points of time, our funds will be a good representation of the underlying universe. These are somethings which we have done and in fact we have launched the liquid fund currently and for the first time I think we are explicitly stating that we are going to invest only in companies which have long-term rating of AAA. It would be surprising for some of our viewers to know that the long-term scale is a typically 20-point rating scale, while the short-term rating scale is only nine points. So, even an AA-minus rated company can return A1+ rating, which is the highest short-term rating. Even a bank which has a single, A-minus rating, which is fairly low on the long-term rating scale, you would get an A1+ rating. So, the entire short term below one-year papers in mutual funds or in the market are mostly rated A1+ and they don’t do a good job of distinguishing between who is a good issuer and who is not so good issuer because everything is A1+ rated. I know investors who would clearly turn away from funds if I gave them a fund of AA-minus companies. However, if I gave them a fund of the same companies which were rated A1+ plus in the short-term scale, they would happily accept it. So, we are saying that we want to make a distinction. While we are investing in the short run, we will concentrate on the long-term ratings and only invest in those companies whichever long-term rating of AAA, and we will also apply our four-filter method along with Crisil. So, this is probably the first time that a fund has explicitly stated that even in for liquid funds or for money market funds, we are going to apply the long-term ratings.
What do you make of this scare among investors currently because of the fact that some of the funds recently have given negative returns on a period of six-months and one year basis as well as of course, from where it comes from but a fear of what could happen to real rates and how low can they go, etc., and what could that do to investments and returns thereof?
SANDEEP BAGLA: Real rates can go low, real rates can go to negative too because in times when output gaps are large to spur the economy, the western countries have frequently taken their rates to negative. In India, we are nowhere close to negative real interest rates. We still have positive interest rates but probably not as high as the foreign investors want and so, in the last six months I saw that a few mutual fund schemes or bonds have given negative returns but that is not a cause for concern. There was some amount of heightened volatility spike in yields after the budget when the borrowing programme was increased and almost doubled. After that there was also a scare in terms of some valuation of AT1 bonds which led to a further spike in yields in bond markets but thankfully it has subsided and the last one-month returns have been mostly double digit for a slightly longer-term mutual fund schemes. In equity markets when markets fall, people tend to invest, however, in fixed income when there are negative returns which means that the market has fallen, not too many investors jump in. Although what I have seen in recent terms is that the smart investors have started buying bonds directly into their portfolio and have started taking some select credit risk also in their funds. So, I don’t think that negative returns for the last six months are anything to worry about. Whenever there are spikes in interest rates because there are developments which are against the market consensus or expectations, there would be negative returns for short periods of time. But if you look at the last three-year or five-year returns, income fund and gilt funds have given handsome returns of 7-8%, which are not so bad.
Do you have any thoughts on the kind of product the Trust Asset Management’s CEO spoke about? You may not have looked at their product but initial thoughts are welcome. But first, this whole chatter around some of the debt funds which have given negative returns, how should one approach this?
VISHAL DOSHI: It is quite unfortunate that debt investors have had to go through a little bit of a hard time because we have seen multiple defaults which have happened. As a result, many of the debt mutual funds gave negative returns. So as investors, I would suggest if somebody is already invested in one of these funds which has taken a hit due to some kind of corporate debt default, my personal suggestion is to avoid such funds and invest in some other kind of a fund. Either way, the banking and PSU space or the low duration space, if the investor wants to remain in the debt side of themes. Because there are even very good names like say UTI, Reliance which is now Nippon, they have had to take hits on their debt portfolio. Now as a retail investor, it becomes very difficult to analyse the portfolio and figure out if there are some weaker names in the portfolio. Ratings and all are fine but in the end, we’ve seen even AAAs come down to A ratings and then default in a matter of few weeks. So, that is very difficult for a retail investor to analyse. So, my personal suggestion is to avoid such funds. Just as a disclosure, I am personally not invested in any of the credit risk funds and I have neither advised any of my investors to invest in such funds.
You may not have individual recommendations on any of these funds but the point being names like UTI Credit Risk Fund, BOI AXA or Baroda Treasury Advantage have kind of not performed as per the mark. I think Nippon Fund, too, hasn’t done all that well. Would you believe that people who are in these funds for whatever reason should get out and invest somewhere else, or should they stay on in the hope of recovering some of the lost trough?
VISHAL DOSHI: As I mentioned, I believe that investors should avoid these funds even if they are invested now, they are better off investing in some other space.
Take out the money and go somewhere else?
VISHAL DOSHI: Yes, that is my personal suggestion because defaults are already in a segregated portfolio. So, as in when recovery happens, which happened in the case of UTI Credit Risk Fund, the investor is anyways going to get that amount which is recovered from such an instrument. So, there is no loss for the investor as such by getting out right now.
You may not have studied the products from Trust AMC, we spoke about the limited passive or limited active portfolio and they’ve launched a liquid fund. Could this be an interesting product; and part two, I don’t think there is too much of differentiation possible in liquid funds, so what kind of investor should choose a liquid fund?
VISHAL DOSHI: I believe, somebody who wants to park his money, say for a few weeks, probably a month or maximum two months or so. I think that kind of investor should look at liquid funds. Now specifically regarding Trust Asset Management, Sandeep and Anand, who formed the key team, they bring many years of experience with them. Having said that, it’s a new AMC, so my personal suggestion is always to look at the track record. Let the AMC build a track record. Only after that retail investors can start looking at AMCs.
One quick question on whether or not the policy in itself did anything to change your outlook towards a particular category of debt funds? The hypothesis generally seems to be that rates might be on their way up, how should a debt market investor prepare for this? Should the investment be in low duration passive products or would you recommend something else?
VISHAL DOSHI: The hypothesis is that the rates are going to go up which is what the market seems to indicate. In that case, I think investors should remain at the shorter end of the curve. So, low duration funds and banking and PSU kind of a category—I think that is best suited. Needless to say, investors should avoid long duration funds or even medium duration funds. Plus, given how the Covid-19 scenario is again panning out and we are seeing a series of restrictions if not lockdowns again happening, in that scenario, even the credit risk category should be avoided. That is my personal belief.
What are you recommending? Let’s work with an assumption that an investor is agnostic about what category he/she puts in. They don’t have a particular timeline in mind or want to take some exposure to the debt category because of diversification purposes. What’s a good debt fund to invest in and if it is suitable for a particular duration or a particular category of investors, then please spell that out as well?
VISHAL DOSHI: As I said the banking and PSU is a category which, personally, I like because it provides the safety that an investor requires. I think Axis Banking and PSU Debt Fund is a good for an investor, closer to 86% of the portfolio is in AAA-rated securities and needless to say, the rest is in sovereign. So, almost 100% of the portfolio are in safer assets. So, investors are in a horizon of 6-12 months should look at this category and this particular fund.
Any balanced advantage fund that you would want to recommend? Is it a good category?
VISHAL DOSHI: Yes, balanced advantage is a good category to be in, given the kind of volatility we are seeing in equity markets, the balanced advantage category has an advantage of moving in and out of equity or lowering the equity allocation of the portfolio. So, in this category, we have an interesting fund which is Edelweiss Balanced Advantage Fund. Now the interesting part of this fund is that it is a pro-cyclical fund. What I mean by a pro-cyclical fund is that, the fund would increase its allocation in a rising equity market and decrease its allocation in a falling equity market. Now many of the other Balanced Advantage Funds would either be counter cyclical, or they would have a strategy where they would increase allocation when the markets are going down. So, in this case, the fund has a pro-cyclical approach, which is rather unique plus the fund also encompasses many factors which are related to say the macros or sentiments or the liquidity in the market or the valuation of the market. So, in all, I think most of the facets by which the equity markets react they are taken care of by this fund and those are the factors which are considered by this fund to increase their equity allocation. The fund that has a mandate to decrease the equity allocation to as low as 30% and increase it to as high as 80%. As I understand, currently the allocation is around 55%. So, this is one particular fund in the balanced advantage category which I personally like, and I would want retail investors to look at this fund.