What is your near to medium term outlook on the debt market?
We expect both growth and inflation to be subdued in medium term. This should provide space to policy makers for continuation of accommodative stance. Monetary policy has been used aggressively till now and incrementally unconventional measures will be the preferred policy choice rather than pure rate easing by RBI.
We expect further fiscal measures to support growth once lockdown is lifted completely. Abundant surplus liquidity is here to stay for a foreseeable future and will be withdrawn in a non-disrupted manner over medium term. Thus, debt markets are likely to be range bound as lower policy rates and surplus liquidity will provide support to yields and fears of fiscal supply will be a reason of worry for the debt market.
On the credit curve, we are incrementally of the view that the worst of the credit crisis is behind us on back of relatively abundant liquidity and various regulatory relaxations by policy makers. Thus credit spreads are likely to at least “mean revert” to historical levels over the medium term. Incrementally, we stand focused on curves which are focused on liquidity play along with good quality credit spreads selectively.
What will be the key driving factors for debt funds?
Pace of global growth recovery, incremental fiscal measures, stable rates, abundantly surplus liquidity, regulatory relaxation to support stressed sectors.
Recently, we have seen that some debt fund managers have chosen government securities over Indian rupee-denominated corporate bonds. They feel spreads on corporate bonds need to be higher to compensate for the credit risk. What are your views on this? What opportunities do you see in this space?
Corporate bonds spreads are indication of credit and liquidity risk of the issuer. This liquidity risk is driven by overall banking system liquidity, demand for credit in the economy, quantum of primary issuance in capital markets and access to the repo market to fund temporary ALM mismatch of holders of these bonds. Credit risk is driven by credit worthiness of issuers and overall sentiments for credit risk prevailing in the system.
Since March 2020, apart from rate cuts, RBI has undertaken various monetary measures (CRR, LTROs, announcing moratorium for borrowers, special windows for sectoral needs) to ease financial conditions and bring down both credit and liquidity spreads. As a result, AAA corporate bond spreads have rallied to below historical median levels and non AAA corporate bonds have rallied near to median levels.
Given these policy measures are likely to stay over the medium term, we expect spreads to remain lower for longer now as “new normal”. Thus we are neutral on AAA corporate bonds spreads and remain constructive on non AAA corporate spreads for further compression.
Gilt funds have given handsome returns in the last one year. How do you see this category performing in the near-term? Also, how will RBI's policy actions impact the category?
As mentioned above, we are near the end of the rate cut cycle. However, RBI may announce some measures like targeted LTRO, HTM limit relaxations, OMO calendar to bring term premia on sovereign curves down. On the risk side, another round of fiscal measures could be potential party spoiler.
Do you see room for more rate cuts by RBI? In this regard, how should investors play the duration risk?
As discussed, we expect one more rate cut in this cycle. Rather than pure rate cuts we expect there would be regulatory relaxations to further ease financial conditions. As term premia remain elevated, we understand there are tactical opportunities in duration.
Why do you think Banking & PSU Debt Fund is suitable for investors in the debt space?
Over medium term : (1) Liquidity is abundantly surplus and likely to remain so (2) Absolute level of rates are likely to remain lower (3) Although rates have rallied significantly in the last 6 months, but given term premium are steep, these adequately compensate investors for taking duration calls even at these levels. While days of easy capital gains on duration may be over but these funds which focus on 2-3 year of maturity are still attractive accrual opportunities compared to other categories.
How should investors design the core part of their debt portfolio at this point?
Incrementally core portfolio should have larger allocation to: (a) good quality credit spreads as they are still away from median levels and likely to mean revert (b) Funds which are focused on investing on 2-3 corporate bonds as term premium over ultra-short term rates continue to be adequate in the backdrop of macro conditions.
