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WF: What is your overall take on RBI's monetary policy decisions and statement?
Lakshmi: I think it was on expected lines. One clear takeaway is RBI's visible mellowing on its stance on inflation. We are now talking about a range of 2-3.5% for first half, which was as high as 4.5%, and second half range of 3.5-4.5%, which was earlier 5.5%. This serves as some sort of verbal easing if not literal easing of the monetary policy stance. Secondly, we saw a divergence for the first time in views of members of the MPC, with one dissenting note to 5 members voting in favour of status quo. Going forward, the key variable that RBI is going to track will be the extent to which inflation remains subdued, and as long as it remains this way, that's good news for bond markets. The cut in SLR is not going to mean much to markets, as most banks are anyway significantly above existing limits.
WF: In recent months, some fixed income managers had turned very cautious on market outlook due to inflation concerns as well as oversupply concerns. Are these concerns now firmly behind us?
Lakshmi: Speaking about our fund house, we have consistently been very vocal that we do not share these concerns on upside risk to inflation. With RBI's current inflation guidance, and after seeing the final GST rates which are not inflationary, I think we can say that inflation concerns were clearly overstated and are not an issue.
WF: What therefore are your target yields on the 10 yr G Sec by March 2018?
Lakshmi: The new 10 yr benchmark paper has already made a journey from 6.79 to 6.56% levels - close to a 25 bps reduction. I don't see significant reduction in yields in the 10 yr segment going forward. I think the key alpha driver in the bond market going forward will be the flattening of the yield curve. Before this policy announcement, the spread between the 10 yr bond yield and the 25 yr bond yield had reached 70 bps. This spread reflected the earlier hawkish stance of the MPC and the resultant caution in the markets - nobody wanted to own long dated papers in such an environment. In the changed context, there is likely to be a lot more demand for long dated paper, given how attractive the spreads have risen to. Long end is where the sweet spot is for the market now.
WF: Does this mean duration funds are back in play now?
Lakshmi: I have been maintaining that durations funds could well be the dark horse in the bond markets and current events continue to support this view. That said, I don't see a gush of incremental money coming into duration funds in a big way - so from that perspective, they may not become "flavour of the season". But sentiment clearly will change for the better for duration funds.
WF: Moving to the other side of the fixed income markets, accrual funds are now back in focus for credit risk issues, thanks to recent newsflow on high profile ratings downgrades and the direct or indirect exposure of accrual funds to some of these names. Is there reason to worry on this count?
Lakshmi: In school, we read this story of the fox who tried to get hold of grapes and couldn't, and therefore concluded in spite that the grapes are sour. That's pretty much what is playing out in the accrual funds arena. Every downgrade is promptly being viewed as a default. Every business cycle sees upgrades and downgrades, there is nothing new here. What is important to understand in the perspective of downgrades is whether a particular downgrade is an isolated incident caused by company specific factors, or an early warning of an industry wide issue, or for that matter a symptom of a deeper malaise in the economy.
The scenario at an aggregate level is visibly improving - interest rates have come down, access to funding has improved. Credit is completely bottom up - just like stock picking is. There are enough and more attractive opportunities in the corporate credit market, and corporates access to capital markets is expanding at the expense of bank credit - which means even more opportunities for credit funds to choose from on a bottom up basis.
Despite all this, if we keep hearing about rising concerns on credit accrual funds, I really think it is a case of grapes are sour!
WF: What is your advice to distributors on casting debt portfolios for their clients in this environment?
Lakshmi: We have been maintaining our guidance to go for a core and satellite strategy - where the core will remain corporate bond funds and short term plans while the satellite of 10-20% based on risk appetite, should go into actively managed duration funds. We put out a note towards the end of May, calling for a visible softening in yields in the near future - which is panning out well. Whenever we have been asked in recent months about whether investors should exit out of durations funds, our answer has been a clear no. They have place as satellite holdings - one can add tactically on dips, but staying put enables one to ride through volatility and gain upsides like what we are seeing now.
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