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The year 2017 has proved to be an interesting one for both fixed income and equities alike. Since the start of the year, the market participants have been left second guessing as to what the Reserve Bank of India's action will be. With the inflation targeting mechanism in place, it was widely expected that a rate cut was due and that is where the market was surprised. In its February Monetary Policy, RBI changed its stance from being 'Accommodative' to 'Neutral'.
Given the unexpected move, bond yields reacted negatively, with the yields on government securities rose by 0.30% to close at 6.74%.Given that normally people look at fixed income from a point of what the Reserve Bank is going to do, rather than looking at the macro fundamentals of the economy, this was a dampener for the fixed income market.
However, this is where the opportunity was for a contrarian investor. Of all the asset class, debt emerged as the relatively better asset class. This stance was on the backdrop of attractive valuation, negative sentiment and an investment scenario wherein private sector capex and credit growth were all hovering near its all-time low. A hawkish RBI meant that the fixed income cycle just got extended. (Read more details from our previous communication:
http://wealthforumezine.net/AMCSpeakICICI100317.html)
Similar was the case in 2014, a time when fixed income market was attractive during the early part of April when yields were around 8.5-9%. Most of the investors chose to remain on the sidelines with a view that invest in fixed income only when RBI starts to cut rates. However, when the rate cut actually started the markets had already reacted as the yields moved to 7.8% from 9%. As a result throughout the rate cuts in 2015, the yields hardly reacted. This clearly shows that second order thinking is required.
Cut back to 2017, the same pattern was under play all over again. ICICI Prudential AMC's investment call had a buy call as we believed the macro fundamentals presented an interesting opportunity. Consequently, we increased maturities in our portfolio as the yields had gone up. In April and May when benign inflation data came by, RBI changed its inflation projection by sharply revising its inflation target lower by 100 bps. Investing at higher yields provided our investors opportunity to pocket gains through the last three-four months. All this for us entailed going against the larger market perceptions and taking a stand as a contrarian.
Given the stance ICICI Prudential AMC had, many of the funds gained smartly.
Source: Value Research, Data as on June 29, 2017.
Disclaimer: Past performance may or may not be sustained in future
Now it's time, to consider if there are more legs to this rally. For the same we would to consider some macro economic parameters. Over the past few years, we have been trying to understand the macro fundamental factors and position the portfolio in line with the macro fundamental factors, which has helped aided the performance of the funds.
Economic parameters under consideration:
Consumer Price Index
Inflation has risen mainly due to rise in food and fuel prices. Excluding food and fuel prices, inflation has been stable. We believe that inflation will be in line with RBI's expectations with a downward bias.
Controlling Fiscal & Current Account Deficit
Source: CRISIL; F -Forecast
The government through its policy is trying to control deficits. This will help build a case for lower government securities yields
Gross market borrowings by the general government (% of GDP)
Along with deficit the government has been controlling the level of it's borrowing from the market
Deposit vs. Credit Growth
Credit growth has bottomed out. We believe from this point onwards, credit growth is expected to increase
Rupee Resilience
The Indian Rupee has been in a relatively stable phase with the new government in power
The Way forward...
We, continue to believe inflation will be in line with RBI's target, with a downward bias, owing to Government's prudence fiscal actions, normal monsoon along with globally moderate commodity prices.. This is likely to provide further room for rate cut as the prevailing high real-rates are not sustainable. Therefore, it is very likely that yield may drop further. Historically, whenever real rates are positive, fixed income tends to be the relatively better performing asset class>
The implication of GST is another important factor. It may be initially disruptive for growth as vendors will de-stock, which is likely to impact growth. Also, the rate of GST for larger CPI basket is non inflationary, which is a positive for fixed income markets. Additionally, lack of private investment, low capacity utilization coupled with lower demand for housing loan owing to change in tax structure for real estate investments and demonetisation is expected to keep the credit growth low in the near-medium term. However, banks are left with substantial liquidity which has not yet made its way to the lenders.
Owing to this setting, it is imperative that the economy would require investments and demand creation. For this to take place interest rates need to come down. Consequently, along with the fall in inflation in line with RBI targets will provide ample opportunities for the Central Bank to cut rates and hence the play on fixed income.
Based on the above factors, we hold a bullish stance on yields and recommend investors to invest in short to medium and dynamic duration funds.
On Debt Valuation Index
Debt valuation index shows that investors could choose moderate duration or model-based duration funds as they may offer better risk-adjusted returns.
ICICI Prudential Ultra Short Term Plan
ICICI Prudential Dynamic Bond Fund
ICICI Prudential Short Term Plan
ICICI Prudential Long Term Plan
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
The information is only for distributors and Advisors of ICICI Prudential AMC and the same should not be circulated to investors/prospective investors. All data/information used in the preparation of this communication is specific to a time and may or may not be relevant in future post issuance of this communication. ICICI Prudential Asset Management Company Limited (the AMC) takes no responsibility of updating any data/information in this communication from time to time. The AMC (including its affiliates), ICICI Prudential Mutual Fund (the Fund), ICICI Prudential Trust Limited (the Trust) and any of its officers, directors, personnel and employees, shall not liable for any loss, damage of any nature, including but not limited to direct, indirect, punitive, special, exemplary, consequential, as also any loss of profit in any way arising from the use of this communication in any manner.
Nothing contained in this communication shall be construed to be an investment advice or an assurance of the benefits of investing in the any of the Schemes of the Fund. Recipient alone shall be fully responsible for any decision taken on the basis of this document.
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