Can you take us through your investment philosophy?
DHFL Pramerica Mutual Fund manages around Rs.24000 crore in fixed income, spread across a range of debt products. The guiding principle across the products is to deliver steady and stable returns / income for investors while keeping volatility and risk under check.
Credit / accrual funds aim to generate income for investors through a process of investing in a portfolio of well researched securities wherein the risk-return reward is optimal.
Duration funds target to deliver returns / income by actively managing duration through the rate cycle.
What is your outlook for fixed income market for the next two years?
Fixed income products have for a broader part of the year rallied, barring the early part of the calendar year. In the first two months of the year, yields moved higher post which we have seen consistently falling yields.
Liquidity has been a big game changer since RBI has changed its stance and shifted to ‘neutral system liquidity’ as against ‘negative system liquidity’ earlier. This has led to a secular rally on yields.
Secondly, government expenditure has gained momentum in this fiscal year which has also released liquidity. The third factor has been global liquidity. Post Brexit, when markets were on the brink, the response globally has been to counter this with more liquidity; some of the liquidity has also come into our markets.
The combination of these factors has led fixed income markets to do well. So going forward, I think the markets will be stable and do well over the next few years.
Where do you see the direction of yield curve in the near to mid-term? What will be the key driving force for yields?
We have had a 80 basis point rally in the last five to six months; yields are expected to slide lower though gradually from now on. Liquidity and inflation are the key driving forces which will help yields move lower. Recently, inflation has not been supportive but in our view it is temporary. We think inflation will cool off due to good monsoons. So our expectation is that inflation should move down to 5% by March 2017.
What are the key risks for the debt market at this juncture?
From a fund manager’s perspective, risks emerge when most factors turn positive and a status quo is expected to continue for the foreseeable future.
In recent times, the reform wave has been rather strong. The government has introduced strong reforms and the parliament has also passed the GST bill and most of the parameters are under control.
However, commodities’ is a sector we have to monitor where crude has been on the softer side for a long time. So at this juncture, I don’t see any risk for the debt market in India but the risks depend on the global market, for eg. FED rate hikes and geo political events.
With new governor coming in, what do you expect from the central bank? Do you anticipate rate cuts this financial year?
Urjit Patel was already a part of the existing team with Dr. Rajan. In fact, he was also heading the monetary policy committee and in charge of key reforms. So we do not expect a material change in the direction. The new governor is expected to push for continuity.
In the near term, we are not expecting rate cuts but by the end of current fiscal year, we think some space may open up for RBI to consider rate easing.
SEBI wants fund houses to reduce expense ratio. Is there any scope of reducing expense ratio in debt funds?
At this juncture, expense ratio on most of the debt fund products are already very competitive and well below the permitted regulatory caps. For instance, in the short end liquidity products the expense is less than a 10th of the cap allowed by SEBI. Market forces are at play and have been ensuring that the overall cost for investors in mutual fund debt products remain competitive.
SEBI has recently hiked exposure limit to housing finance companies HFCs for debt funds to 10%. How will this benefit investors?
This has been a positive step particularly for fund investors. Financial services have been the fastest growing sector globally. This is obvious because the funding requirements from NBFCs and Housing Finance are the largest and also the rating of these companies has been stable over time.
Credit funds and gilt funds have not done very well during three and five year period. It is just around 30 to 50 basis point above the average liquid fund returns. Why do you think is that so?
Over the last five years, G sec yields have witnessed volatility, especially over 2013-2015. Factors leading to the volatility include global factors such as taper worries starting June 2013 and India's own weak external debt position which led to a significant decline in the value of the rupee. This led to a spike in yields as policy rates had to be hiked.
Over the last 6-9 months, however, we have started to witness the positive effects of stabilizing macro which is reflected in a stable rupee as also a gradual decline in yields. Inflation parameters have also eased (despite the slight recent reversal) compared to the prevailing levels 12-18 months earlier. These factors in our view have paved the way for a gradual decline in volatility in the fixed income space in the medium term. Sustainability of the recent positive outcomes will get durable as the recent reform moves get further institutionalized (such as the recent formalization of the inflation target of 4% with a +/- 2% variation).
Credit fund performance over the same period has been relatively more stable. The accrual funds typically have more of a buy and hold strategy as against the duration funds which adopt an active trading strategy for alpha generation. As such the credit funds have performed relatively well over three year periods. Going forward these funds are also likely to benefit from an improvement in liquidity and a general decline in yields. In our own credit fund, the average maturity positioning is 2-4 years which offers participation in yield declines and also hedges against any unforeseen short term volatility.
SEBI has released a report on strengthening corporate bonds market and urged FPIs to invest in corporate bonds. What is your opinion on this?
SEBI and RBI have taken various positive steps to strengthen corporate bonds market over the last three years. But it will take time before it can be fully operationalized. FPIs are a class of investors who understand the corporate bond market really well. So allowing them to invest directly in corporate bonds is a good step. But the only thing to borne in mind is that corporate bonds are not very liquid yet and FPIs normally prefer to come into segments which have higher amount of liquidity.
Currently, there is hardly any action in AA and below rated debt securities. This may be posing challenge for fund managers to generate alpha. Keeping this mind, how difficult is to generate double digit returns in debt funds for investors?
From mutual funds perspective, the funds that can invest in AA securities have been growing. Most of the fund houses today have corporate bond fund while liquidity of these bonds is not good as G-secs or AAA rated funds, it is far better as compared to three years back.
But for low rated securities, the activity level has been low because every fund house has a mandate for credit securities. For instance, in our own case, we do not invest in securities which are rated below single A. So participation in below A rated securities will remain low because the investor acceptance of such portfolios still has areas of improvement.
Which category of debt funds would you recommend investors at this juncture?
Investors looking at very short term horizon would be advised to consider liquidity products such as liquid and ultra short term funds. For investors with a slightly longer horizon beyond three months, we would advise short term funds and their variants. Investors with slightly higher risk appetite could also consider some allocation to accrual products.
