‘The near-term outlook for debt markets is likely to be positive’

What is your near-term outlook on the debt market? What will be the key triggers from here on?

The near-term outlook for debt markets is likely to be positive. We believe central banks across the world including RBI are getting closer to the end of rate hiking cycle. Barring any unforeseen risks like disappointment on account of progress of monsoon in India and/or rising geopolitical risks, most other macro-economic variables like fiscal deficit assumptions, pace and trajectory of disinflation, strength of India’s external sector indicators are all evolving in line or better than expectations.

These variables increase the conviction around our base case view of no further rate hikes in the near term. The recent pause by RBI could over time turn into a pivot and potentially could lead to rate cut expectations once clarity emerges on some of the unforeseen risks.

Dynamic interest rate scenario and the removal of LTCG appear to have made investors more inclined towards other hybrid products. How can MFDs tackle this?

The fundamental benefit of a mutual fund over other fixed income products is the availability of liquidity at a short notice. Further, the tax component in debt mutual fund is only payable on redemption and not on change in NAVs.

The fundamental rule of investing that ‘Product should always be chosen basis its fitment in the risk appetite profile of the investor matched with investment horizon’ should not be done away with given the changes in taxation structure.

MFDs can communicate to their investors the long-term advantage of good asset allocation than getting swayed by changes in taxation.

Debt funds have not performed well over the last 3-year period. Many categories of debt funds have delivered returns less than inflation. Why do you think MFDs should continue to recommend debt funds to their clients and justify its worth compared to FDs?

Duration of a debt fund is the beta/measure of volatility, higher the duration, higher the interest rate volatility.

RBI hiked rates by 290 bps (repo rate by 250 bps plus additional 40 bps of reverse repo equivalent hike) coupled with withdrawal of liquidity surplus (effectively equivalent to another 25 bps). This led to returns from fixed income products being subject to negative mark to market impact.

However, MTM is always a notional loss unless actually realised. For eg. if one locks in investment at 5% for 3 years and interest rates move up by 2% after 1 year, there will be a negative MTM implication after 1 year, but if one remains invested till the end of tenor, the realized annual return is likely to be close to 5% at the end of three years i.e. the initial return which you had initially invested for.

The fundamental advantage of a mutual fund product over any other fixed income product is the availability of liquidity at a short notice along with flexibility to shift asset allocation.

Which fund categories of debt funds should MFDs recommend in the current scenario?

We have always advised our investors to choose the best fit from our product basket which is positioned across the interest rate yield as well as credit risk curves, depending on their individual risk appetite (as measured by the tolerance to volatility) and investment horizon.

Given our strong conviction around the India growth story leading to India transitioning from an emerging to developed economy over next few decades, we believe that the long-term trend for interest rates in India is lower.

If we were to look at the historical trend interest rates in India they have been consistently falling over the last two decades. In such an environment it becomes imperative for investors to start hedging their potential reinvestment risks by locking in for longer periods.

How can MFDs make debt funds simpler to their clients? Tell us at least two things that they can do to simplify narrative around debt funds?

Our first and foremost advice would be to remain very careful at the product selection stage. Product selection must be done keeping in mind not only the investment horizon but also the risk appetite of the investor as measured by their willingness to tolerate volatility in the intermittent periods. Having chosen the product appropriately, our second piece of advice would be to endeavour to stick to it regardless of the intermittent bouts of volatility.

Our final piece of advice would be to choose wisely when it comes to selecting an asset manager/fund house keeping in mind not only their investment philosophy but also the discipline they have demonstrated across multiple interest rate and credit cycles.