The Mutual Fund Show: Options For Fixed-Income Investors

GURMEET CHADHA: Excellent choice, because I think people just colour debt investing as just one umbrella and they don't do sub asset allocation which in my view is very important. I can add a few basis points which can make a material difference and not all debt investments are risk free. We've seen various sources and not only the credit ones but sharp movement in interest rates in 2013, you're seeing some of it since last month with some of the yields hardening. So less than one year we divided it into basically two buckets. One we called it as an on-demand bucket which I may need money in the next two months, three months, four months in that kind of a horizon, you can look at liquid and ultra-short-term funds in that space.

AMIT BIVALKAR: When you talk of safety, then clearly return is not something that you should look at, that is rule number one. But if you're looking at safety clearly you have got some banks who are trying to attract deposits at 6-7% also, that we all know. So, you have got some private banks which are taking money at 5.5-7% from clients. I think that's a pretty decent alternative. No need to move money from there but what I feel and as a company, what Sapient actually is advising clients, is we believe that there is a fight between the market participants and RBI on when the rate reversal will happen on debt. So, one-year money, if you divide between below six months in above six months, we are advising to put money into roll-down funds, which are having maturity on March 2022 and you will have those funds that will not have, or rather I should say the least impact if there was a rate reversal in the market. So, namely funds like a DSP Savings Fund, which has a March 2022 maturity, or Invesco Money Market Fund, which has a March 2022 maturity, or you look at even a corporate bond fund of DSP, it has March 2022 maturity too. You've got Axis Banking PSU Fund that has a June 2022 maturity. So, money which is there for six months we are advising people to put in roll down which are maturing in March 2022, so that you will have minimum reset. This time in debt, what actually one should look for is protecting your capital, because as Gurmeet said your interest rate risk because of the duration is going to be very high had the rates reversed. So, when you're putting money in debt, what RBI is actually doing is because it's a lower-for-longer kind of interest rate scenario, every investor is actually pushing himself one level of risk higher than what he's sitting at. So, an ultra-short-term guy is moving to maybe a low duration or low duration is moving to a short-term or short-term is moving to medium-term and medium-term to a bond fund. I think one should not get enamoured as the yield to maturity is on these funds right now, but we should actually look at what is the maturity profile of your investment and what is the maturity profile of the fund. We have been all taught through 2015 till 2020 that it is YTM minus expense that you will get on a debt mutual fund. I think now it is going to be YTM minus expense minus capital loss, if you're going to mismatch your maturity. So, what is more critical is if you have that kind of money, we are suggesting March 2022 roll downs with these three four funds what I told you, and rightly put by Gurmeet I think above six months money, you can definitely look at arbitrage funds because they offer a 15% tax compared to a marginal tax rate on a below three-year debt fund. So, arbitrage definitely makes way for these but most important point is you have to get immunised from the reversal in interest rates and because of that I think staying short till about nine months to 12 months of maturity funds, this is what we have been advising. One important thing is that whether interest rate reversal will happen quickly—May was lockdown in India. If you try to look at the inflation number which has come out, the May number actually captures 67% of the total inflation number essentials and the June number also which came out it came because of 80% of the total commodities goods and services which are calculated for inflation. So, we have not yet looked at the entire inflation number and if this surprises you on the upside, then you will see some interest rate movement happening and therefore, one needs to be cautious when it comes to below one-year investments.

GURMEET CHADHA: As I said debt funds carry three kinds of risks—credit risk, duration or interest rate risk, and liquidity risk. So, I covered the interest rate risk and let's say there is a bond trading at Rs 100 and offers you 5% exit coupon on one year, interest rates will go up by 1% as Amit was pointing out. The new bonds in the market will come at 6% so nobody will touch your bond at 5% which means the bond at 100 will have to start trading at 99 to make up for that 1%. So, if your bond would start trading at a discount, it would reflect in your NAV. So, if you have a one-year horizon and your maturity is also of one-year, over a period of time that discount will eventually mature and get face value but if your maturity is three years and the impact would be 3%, you came with a six month horizon in a three-year maturity fund, you might just end up losing 3% which is almost all your return that you would have probably made in six months. So, in a rising interest rate environment in fact in any environment for that matter, your horizon and the duration of the portfolio should be in sync.

GURMEET CHADHA: It's available on the public domain on various websites. It is called modified duration. It is a measure of interest rate sensitivity of the portfolio. So, if modified duration is one, which means if the universe goes up by 1%, my portfolio will also move by 1%. It is both ways there's an inverse correlation. Take note of that and also look at the portfolio very closely. Just look at the credit quality very closely, you should not have names which are not very comfortable with and if you have more AA names. In arbitrage, the top names are Kotak, Tata, Nippon—I think they've done very well. I must tell you that the difference is not very much, but every basis point counts in the end. In ultra-short-term, there is ICICI ultra-short-term fund. Amit spoke of the Birla Savings Fund. So that category can be looked at and I agree with him, some roll down maturity, again his point was that maturity is March and June, so it should coincide with it. Just to give you one more clarity rolled down maturity means the maturity will keep reducing. One is constant maturity that means that the portfolio will always have that kind of maturity.

AMIT BIVALKAR: One more point here is, what is going to happen is that, for a brave hearted person even the next one year, your credit funds are going to deliver good returns because in the last entire one and a half years there is no credit pickup in the market, so you don't have any credit which is given by the banks or mutual funds any which case. The second thing is the cost of money is so cheap that many of the credit guys have actually borrowed at low cost and prepaid their high-cost debt. So even a category like credit will do well but don't mistake it that this is going to be forever. So, the cost of money, and the availability of money, since both are right now in abundance and cheap, you will still see some of the funds delivering better returns but please watch your step. It's like they say in a swimming pool, you have a diving area, children area, relaxation area but the average depth of the pool is five feet but the children area is two feet and the diving area is 12 feet. So, don’t go by the average and don't go by the average return of the fund. It is more important to match your profile with that of the fund.

GURMEET CHADHA: In an arbitrage fund if you see, typically, when the bullish sentiment is there and volatility is high and interest rates are changing, typically the carry goes up. So, right now the carry is about 40-50 basis points a month, which is typically in that 5% kind of a pre-tax bracket, one good thing is, there is some degree of forecasting. I would not say you can forecast arbitrage returns but rollover spreads to a large extent you can figure out a range which will be plus minus 100 basis points. So, five-ish is what right now the spreads are. Let’s say for July the spread is around 46-48 basis points. So, taking 5-5.5% as a pre-tax yield, assuming somebody withdraws before 12 months, and 15%, you will probably make about 4%. Now if you compare that to the fixed deposit at 4%, let's say for SBI 3.5-4% post-tax, and if you have the highest slab, then 3%. So, if you have the return differential could be around 100 basis points.

AMIT BIVALKAR: I think you will end up with a YTM of about four-and-a-half percent to quarter to five, when it will come to roll down maturities. That is what you will look at March and June of 2022.

AMIT BIVALKAR: On the mutual fund side, clearly, I would say don't go for the bond ETF categories which people are selling for two-three years from now, I think one should avoid that because the differential between what you can say cash deployment and incremental investment is actually very little. So, I would still wait for the next March or April to get a good yield on my portfolio and then redeploy that money rather than hurrying it right now and putting in money. One thing, apart from mutual fund what you can look at clearly, is you have got 2023-2024 perpetual bonds, have banks like State Bank of India and Bank of Baroda, which are still giving you 6-6.5%. So, if you have the wherewithal to buy these bonds because there is a call option on these, in November 2023 and 2024; if you have that two year to two-and-a-half-year kind of money, then these bonds actually will be a better option than going in for a fixed deposit as well.

GURMEET CHADHA: So keep it simple, look for good short-term funds. As the name suggests, the short-term funds carry one to two year kind of maturity profile and so something like let's say like Axis Short Term Fund or a Birla Short Term Fund, there are some short-term funds which can take some bit of credit column but those calls are on some AA+ papers like Tata Power or some of the calls which Amit was pointing out just to give a bit of a kicker on the yield. A good short-term fund again, repeating that point, matching your horizon and the duration. Since I spoke of Axis Short Term Fund, the modified duration is around 1.7 years, so typically an 18-to-24-month money can be parked. The YTMs right now are around five-ish or five quarter. So, the yields unfortunately, have come down. They used to be pretty nice and don't get carried away by the last one-to-two-year returns. We’ve had the best bond market rally behind us. You typically tend to get carried away after seeing three-year returns of 9-10% and hoping that it will repeat that kind of performance but a 5-6% bracket is a good shot. Also, the corporate bond funds like, ICICI Corporate Bond Fund, IDFC Corporate Bond Fund. Some corporate bond funds have also taken some cash calls. They are right now in a situation where they think that the yield curve will revolve more as the RBI is reluctant to add. So IDFC also added some cash to take advantage of it. As I said, please look at the portfolio once. I might sound very technical, but it isn't very technical, we just have to understand where you are investing and what the portfolio is holding. I think if you can do those two simple things, investing isn't that difficult.

GURMEET CHADHA: I think this is where you actually score the most differential over traditional deposit—that is because you get indexation benefit. So, let’s say if inflation is 5%, right now the CPI print is 6, but let's say 5% and you put Rs 100 today and if you add 5% on inflation every year, in three years, your cost of purchase becomes 115 and if you're even getting 6%, then the hundred becomes 120, you only pay tax on five bucks because your cost per purchase is 115. So, there are a few options. I just spent some time on the yield curve, I know it sounds a little fascinating. We have a steep yield because the repo rate was 4 and then 10-year was 610- 620. There was a 200 basis points difference between the overnight rates and the longer end rates. Right now, the juiciest part is that four-five year, that's where you're getting the yields slightly higher. So if you buy a state government bond today, a five-year bond, you’ll get them at 620, 610 or 630.

AMIT BIVALKAR: I think what I will suggest on a more than three-year towards five-year is a combination of 18% short-term fund and a 20% mid-cap ETF. So out of Rs 100, what you have to invest if you have a five-year horizon, if you put 80% of your money that is Rs 80 in a short-term fund and Rs 20 you just go and buy a mid-cap exchange traded fund, you will beat a credit risk fund on any parameters, over five-years. If you want to really make that yield to work for you because five years money, I don't think so you should put in debt any way. If people who are willing to put money away for five years, and if you don't want to take risks on your portfolio, if you put Rs 80 in a short-term fund and Rs 20 in a mid cap, if you find a rolling returns for five years you will beat the best performing debt fund in the market on five-year rolling returns.

AMIT BIVALKAR: That’s the point. If people are moving from arbitrage fund to equity savings category, which has a 16-40% equity exposure naked, which is not covered, that's a bigger risk than taking 80% short- term and 20% mid-cap ETF.

AMIT BIVALKAR: No, I think, if you are not going to look at the volatility which will come because of the interest rate rises in the next one and a half years, I think going for a medium-term fund for a five-year term, you can just go and sit there. The problem is that if interest rates go up, you will see a muted return this year, which is a 3-4%. Next year, you might see 5% the third year, you might see 6%. So, your average is going to be at 5% return on your three-year money that as Gurmeet was mentioning, if you have a five-year bond fund which is at 570 and you don't want to look at the volatility in between so, it's just fill it, shut it, forget it and buy that five-year bond and just sit tight, you will still make your YTM. So, most of the time, if we try to look at what is happening to the NAV, I think that's where the panic sets in, but you need to go and buy and hold strategy on any of the fixed maturity plans which will come out or probably a four-year bond fund or a five-year roll down strategy I think you will make your money anywhere between 5-6%. So, you can definitely look at such options.