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WF: How will the recent SEBI guidelines on debt fund risk management impact your portfolio construction and management?
Amit: The impact, in the short run will be mainly felt in Liquid and Ultra Short Term funds, where the Financial Services Sector exposure may be slightly above the new limits. However these are typically shorter tenor assets and hence shall not have any meaningful impact going forward.
As far as other debt funds are concerned, the portfolios are typically well diversified and we shouldn't have any issues adhering to either issuer, sector or group limits.
Overall these new guidelines will further strengthen the risk profile across debt funds. But given the superior credit performance of NBFCs and HFCs in the past few years, the MFs have to strive harder to maintain this credit performance in their portfolios, while diversifying out of the financial services space.
WF: There are mounting worries on PSU bank NPAs, especially in the context of the commodity rout and its impact on several businesses. Should we be worried as a corollary, about debt fund portfolios on the same score?
Amit: The debt fund exposures in the banking space are typically restricted to money market instruments; with very limited exposure to good quality, long tenor bank bonds. So from an exposure perspective investors need not worry.
Moreover, our take on the banking system, specially the PSU banking system is that there is a huge systemic importance as far as GoI is concerned. So while in a down cycle, the NPA issues may not go away soon, the Government has shown enough commitment in terms of recapitalisation as well as addressing NPA issues through schemes like Uday. The pro cyclical approach from RBI is also bringing a lot of these NPA issues to the fore, which is good from a transparency perspective.
Overall, on a near term basis we are not too concerned in terms of liquidity and solvency of PSU Banks. Over the medium term the health of PSU banks will be driven by their ability to grow while maintaining asset quality, and compete in a rapidly evolving and changing environment.
WF: How have corporate bond spreads reacted in the last 12 months, where we saw 125 bps of rate cuts? How do you expect spreads to move and what opportunities do this offer?
Amit: The high grade AAA and PSU corporate bonds saw a meaningful contraction across tenors owing to improving liquidity, FPI demand, low supply as well as fund flows in the UST and the ST category.
In the high yield space, signs of improvement in the economic scenario, good liquidity conditions and strong flows in the credit funds led to a drop in spreads between AAA and A rating categories. However post a credit event in August, these spreads have again widened and are currently in excess of 200 bps, which is very attractive from an investor stand point.
In our view the shorter end corporate bonds (1 to 5 years) offer good accruals and a potential for capital gains over the next 6 to 12 months. Our comfort comes from the underlying liquidity conditions, potential for roll down benefits from a steep yield curve, low supply of quality corporate issuances, attractive spreads across the credit curve.
Investors should look at investing in funds in the short term category and credit funds with a duration profile of 1.5 - 3 years.
WF: What is the trajectory you foresee for the 10 yr G-sec over the next 15 months until Mar 17? What are the factors you see influencing this trajectory?
Amit: We believe 2016 will be a year in two halves. Fiscal uncertainty will continue till budget, keeping G-Secs yields range bound. Supply dynamics may impact the 1st quarter of FY 17, providing attractive entry levels.
However cautious sentiments around fiscal policy may reduce post budget. Slowing global growth and slower pace of FED hikes will be very positive for India Bonds. Also, FPI flows and RBI OMOs will provide core liquidity and will create fresh demand for G-secs.
The government is committed to fiscal discipline, and the monetary framework is inflation centric. Hence, we remain very constructive on bond yields, if the investment horizon is 12 months and above.
We see a 50-75 bps down move in yields over this period.
WF: On the global front, some experts warn us about an impending junk bond crisis in US and its impact on global markets. What exactly is the situation and how might it impact our markets?
Amit: Given the stress in the commodity and energy space, and the fact that companies operating in this space have been the largest issuers of junk bonds in the past few years, there is concern on the performance of these bonds in light of the steep fall in commodity prices, and the leveraged nature of most of the borrower balance sheets.
While the US markets, by nature are very liquid, and hence price these risks fast, the investor sentiment in these sectors will remain weak due to the recent performance of these bonds.
We have seen similar spread expansion on some commodity and cyclical industry bonds in the domestic market. But the market as well as rating agencies have clearly differentiated between players who are seeing only margin pressures due to the commodity price fall, vis a vis players who have stress on balance sheet due to excess leverage at a consolidated level, and who have low financial flexibility.
We need to be vigilant and restrict our exposures specially where there are balance sheet related issues, in spite of the fact that the pricing may look attractive in some cases.
As far as RMF is concerned, all our credit exposures including exposures to entities in the commodity / cyclical space are driven by inherent balance sheet strength, very high levels of financial flexibility, manageable leverage at the consolidated level, and the superior operational performance matrix. Having said that the overall exposure is very low in the context of our debt AUM and is in very select issuers.
WF: Currency wars is now a key fear in global markets. How serious is the situation on this front and how might it impact our fixed income market?
Amit: Fixed Income markets get a lot of comfort from currency stability. But this stability is always in a relative context, and not absolute.
India has been the best performer in the emerging market space in terms of total return performance (bond returns adjusted for currency movement, with the base currency being the USD), over a 1,2 and 3 years period. And this performance comes with the backdrop of a stable and improving macro and hence a better performing currency.
Currency markets are also the best and the most neutral indicator of any economy's macro variables, and hence it's not in our interest to get into this competitive devaluation strategy, especially when our exports are much more linked to global demand and global trade momentum. Arguably, the elasticity of exports is low to competitive devaluation.
Second, for a capital starved economy such as ours, a stable currency regime is imperative to give confidence to both debt and equity investors who are looking at long term allocation of capital to India.
The government and RBI are on the same page as far as fiscal and monetary prudence is concerned, which makes India stand out even in the current weak environment. This makes us believe that the current bout of currency weakness across EMs will help India stand out even more.
WF: Where do you see the best opportunities now in the fixed income space?
Amit: The 125 bps reduction and the structural improvement in liquidity led to a bull steepening of the yield curve in 2015. The only product category which underperformed in a relative sense was the longer end G-Secs. The main reasons were supply overhang and global volatility.
With a 2 to 3 year perspective we are very constructive on the duration curve and on credit spreads. In terms of product categories that would translate to Dynamic Bond Fund and credit funds such as Reliance Regular Savings Fund - Debt and Reliance Corporate Bond Fund.
The bullishness in the duration space comes from the attractive valuations, the stable macro parameters, signs of slowdown in the global economy and the improving demand equation with fresh FII inflows.
The credit spreads will compress owing to a basing out of growth and incremental improvements across corporate balance sheets. There is a lot of effort being put by the government in terms of clearing hurdles to reviving private demand, and corporates are trying hard to improve balance sheets even in an adverse global environment. Finally our credit portfolios are a good mix of retail, structured and cyclical assets and as such will perform much better than the broader credit matrix given superior research and structuring skills. The search for carry will drive investors towards well run credit funds, and that will also drive a compression in spreads.
WF: What are the key risks you see now in the fixed income space?
Amit: The low nominal growth rates and pay commission overhang has led to speculations of deviation from fiscal consolidation path. In our view, the government needs to follow this path in spirit, without being bogged down too much to last decimal. However if the government is seen dithering from the broader trend of fiscal consolidation, that would be negative from the debt market perspective.
Macro stability, including external macro, has been key to India's outperformance. The next few years should be used to further macro stability so as to attract long term capital flows. We are confident that both the Government and RBI would put macro stability at the very top in their list of priorities. Given that the currency performance is so closely tied to macro stability, this will be a key determinant of fixed income performance.
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