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WF: There is a growing view that its time now to switch from longer duration funds to shorter duration funds and accrual funds. Do you agree with this view? What is the rationale behind this thinking? Is the bonds bull market now over?
Lakshmi: This question seems like wanting to watch soccer or tennis - if it is being aired at the same time! Both games seem interesting and has its own set of fan following..
Yields have softened in the recent weeks, which have led to this growing urge to switch/redeem from duration funds. What is key to understand is that in comparison with the rest of the world, we have hardly seen a rally in India. Also, with around $13 trillion worth of bond yields across the world in negative territory, the chase for yields would likely get stronger. Duration funds have been the best performing category in fixed income calendar year to date, and we expect this trend to continue for the next few quarters. However, given the recent run up in prices, gross yields have reduced in such category funds. Hence on an incremental deployment basis, we are suggesting a higher allocation towards short term/ accrual funds, with a tail deployment into duration with a 3 year perspective.
There is a high probability however that for the next 12 months, duration could continue to outperform accrual category funds. to that extent, the bull run in bond markets has some more steam left before investors call it a day !
WF: Advisors have a dilemma in a falling yields environment to choose between an accrual fund that carries a reinvestment risk and recommend it anyway with a 3 year view for tax reasons vs locking into a fixed return product at current yields (like a tax free bond) with no reinvestment risk for a 5 year horizon. How can you guide advisors on the considerations to be kept in mind when making this choice?
Lakshmi: In a balanced diet, one needs proteins as much as one needs carbohydrates. Proportions could wary from time to time depending on the exact need. Tax free bonds are low on credit risk as most of the issuers are quasi sovereign in nature. They are also issued for longer tenures, so to that extent the duration part of the exposure gets taken care of in ones portfolio. In case of accrual funds, the gross yield differential over sovereign range from 2%-4%, depending on the sector and the issuer. With interest rates having come down, the gap between these categories has remained fairly intact. Therefore there is a potent investment opportunity available for investors having a 3 year plus investment horizon. Of course, the element of credit risk is a tad higher given the nature of bonds, however they are like carbohydrates, which are an energy booster to ones portfolio. The banking sector loan book is over 100 times higher than the MF industry credit accrual funds AUM. The rating profile too is quite different from what MFs own as part of portfolio. Hence there is a case for some co-ownership of accrual funds alongside tax free bonds in ones portfolio
WF: You recently introduced an exit load waiver for SWPs in some of your debt funds. What's the rationale for this move and how should advisors leverage this facility?
Lakshmi: The thought was triggered primarily to necessitate periodic cashflows to any individual. A periodic disciplined form of investing thru SIP is quite well entrenched in the minds of investors. However, the concept of regular potential income through mutual funds, especially on the debt side needed some popularisation. Also, though the average Indian retail investor does have exposure to debt, the same is largely through banking and other traditional products. The launch of Kotak Long term income facility was primarily to plug in this need. We are hopeful that "retail"isation of debt through mutual fund route would get more ammunition with this initiative and advisors would be able wean some portion of their clients' money from traditional mode of debt investments
WF: A lot has been said and written about corporate bond funds in the aftermath of the credit events we saw impacting some of the funds in our industry. As a person who manages fixed income funds as well as takes responsibility for product development, what would you say are the lessons we must learn in the way these funds are managed, positioned and sold?
Lakshmi: Firstly, accidents are part of life - whether on the roads, or as a credit event. Just as on roads while driving, vehicles are equipped with air bags, likewise key is to have 'air bags' as insurance in credit space as well. This would include a whole host of processes and check lists like periodic management meets, surveillance etc. It's akin to a periodic vehicle servicing to ensure no surprises while driving
Accidents make one more vigilant - but does one stop driving that route just because there was an accident? Probably not!! That's the key message to advisors and investors alike. There doesn't seem to be any big mismatch with respect to the positioning and management of these funds.
Finally, there seems to be more fear than greed at this juncture with respect to this category of funds - an opportunity worth capitalising
WF: Global fixed income funds are said to be the biggest bubble right now - waiting to explode. Bill Gross has warned of an imminent explosion and its consequences. What exactly is the state of play in global fixed income markets? How real are these risks? To what extent are we likely to be impacted by gyrations in global fixed income markets?
Lakshmi: Around $13 trillion worth of global bonds are yielding less than zero. This got accentuated post Brexit announcement. Effectively, it means that investors are paying to own these bonds! In Japan, the demand for safe vaults has gone up as people prefer to keep money home!
While this could be a bubble, the lack of faith in fiat currency is driving such behaviour - as a safe haven resort. Hence it is unlikely that the situation would get any better too soon.
India still offers one of the higher yields across the world as also within emerging markets. This 'carry' should lead to some flows into Indian fixed income. INR plays a very important role apart from carry and capital gains which determine foreign flows. With incremental view that INR is likely to maintain stable bias, we expect FIIs to turn net buyers of Indian debt. Already month of July has seen net positive flows, though calendar YTD basis, debt FII flows are net negative. US could be a joker in the pack if they raise rates sooner than anticipated. However the gap between US and Indian yields have widened quite dramatically to offer reasonable cushion even if rates were to rise there.
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