Avnish Jain, Head – Fixed Income, Canara Robeco Mutual Fund talks to Cafemutual about the key risks for debt market, his expectations from RBI and more.
What is your outlook for fixed income market for the next two years? What kind of returns can investors expect from debt markets?
The RBI has created an inflation-focused monetary policy framework in conjunction with the government to accomplish the common goal of macro stability viz. low inflation, stable currency and sustainable growth. Relatively better monsoon has helped stabilize food prices that were a cause of concern over the last couple of years. The momentum of growth is expected to be quickened by better monsoon raising agricultural growth and rural demand as well as by the stimulus to consumption spending. We expect inflation to ease down further to the RBI’s target and it may infuse confidence in the system thereby providing a boost to the overall economy ahead.
With the 10-year yield coming down over last two years, we continue to believe that the appetite in the market is still present. Based on the current market sentiments, we expect the 10 year bonds to trade between 6.65 - 6.85% in the near term which may further reduce in next two years on the back of weak global growth and lower inflation/slow growth prospects in India.
In the recent past, the debt oriented mutual funds have performed better than the expectations of market participants owing to the constant reduction in interest rates and the downward shift in yield curve. With expectations of interest rate to decrease further, the debt market seems to be a good investment avenue as they generate moderate return with lower risk. However, we suggest investors to match their risk-return appetite at the time of investing.
Where do you see the direction of yield curve in the near to mid-term? What will be the key driving force for yields?
With the positive outlook of Indian macros, the interest rates are expected to soften. In the near to mid-term, the intermittent shocks could be felt with the US Fed hiking rates and removal of stimulus of Bank of Japan (BOJ) and other central banks. However, once these global headwinds pass, interest rates may head southwards. The key drivers for softening continue to be weak global growth and deflationary environment.
What are the key risks for the debt market at this juncture?
In the current investment environment, we foresee the following risks to engulf the market participants. While yields are expected to soften, any major geo-political event may negatively impact debt markets and consequently returns over the short term. With the credit quality in the banking system being under pressure, credit risk is also one of the prime risks that investors face. With recent defaults by a couple of corporates and the credit pressure mounting, investors are also prone to default risk. With the constant changes brought by SEBI to streamline the markets, regulatory risk is another risk that the investors should watch out for.
With new governor coming in, what do you expect from the central bank? Do you anticipate further rate cuts this financial year?
The newly formed Monetary Policy Committee decided, unanimously, to reduce the key policy rates. Accordingly, the repo was reduced by 25 bps at 6.25%. Going ahead, the newly formed committee is expected to continue on the path of structural reform of the monetary system with the objective of keeping inflation expectations down and ensure that rate cuts are transmitted to borrowers by the banks. The decision of the MPC is consistent with an accommodative stance of monetary policy in consonance with the objective of achieving consumer price index (CPI) inflation at 5% by Q4 of 2016-17 and the medium-term target of 4% within a band of +/- 2%, while supporting growth. The decision by the central bank is likely to ensure sustainable growth with a low and stable long-term inflation and might aid investment and spending.
Going ahead, easing liquidity conditions may provide cushion to the banks to modestly transmit past policy rate cuts through their MCLRs and pro-active liquidity management should facilitate more pass-through. This is positive for both government and corporate bonds. With inflation expected to fall further on falling food prices, RBI may be in a position to cut rates by 25 bps in current fiscal.
SEBI has recently hiked exposure limit to housing finance companies HFCs for debt funds to 10%. How will this benefit investors?
Today, the borrowing requirement of HFCs is increasing and market expects the HFCs segment to grow at faster pace. Since the hike in exposure limit by 5% has created a room for fresh investments in HFCs, the industry is expected to benefit from the move as a whole. To add to it, all HFCs are well-regulated and the nature of their business is less risky than that of the typical NBFCs. The structural change in the norm is a step in right direction and would help mutual funds to increase exposure in papers issued by good quality HFCs that currently offer higher yields over similar rated issuers in the non NBFC space. This will boost the returns of the debt funds thereby benefiting fixed income investors.
SEBI has released a report on strengthening corporate bonds market and urged FPIs to invest in corporate bonds. What are your views on this?
The measures aimed at expanding the investment basket for foreign portfolio investors (FPIs) were announced in the Union Budget for 2016-17. In addition to the central bank easing norms for FPI, SEBI allowed FPI to trade directly in corporate bonds market without requiring any intermediary. This step would further strengthen the corporate bond market as the majority of it is privately placed. Increased participation of FPI in the corporate bond market would increase the breadth of this segment thereby, increasing the demand of these bonds and could reduce the interest rates further. Going ahead, the limit of FPIs would increase in a phased manner. This will encourage other corporates to take the borrowing route from the market as an alternate to bank funds.
Which category of debt funds would you recommend investors at this juncture?
Efforts taken by RBI to infuse liquidity in the system have resulted in almost a parallel shift in the yield curve. Going ahead, due to positive domestic macros & effective transmission of previous rate cuts by banks, the longer end of the curve is expected to reduce further. Hence over the longer term, we expect the longer term funds like income funds and gilt funds to perform better on account of higher capital appreciation when the interest rates reduce. In the near to mid-term, though the interest rates have a downward bias, intermittent external factors could lead to temporary upward movement of interest rates and in such a scenario, dynamic bond funds or medium term funds could be a better alternative to smoothen the volatility. However, we recommend investors to match their risk and return appetite before investing in any fund.
