Platform For Long-Term Players

Killol Pandya
Senior Fund Manager-Debt,
LIC Nomura Mutual Fund

I think it is a good time for investors with a medium to long-term investment horizon of say beyond six months to invest in debt instruments and products which can take advantage of the softening in interest rates.

With respect to the Indian debt markets and Indian investors, how challenging do you find the fund management industry? 

The mutual fund industry in India has been around for some time now but has picked up only in the last two decade or so in terms of participants and volumes. Over the years, it has become more regulated and competitive. After 2008, there has been a shift in the working environment of the mutual funds. While earlier, it was possible for fund houses to evolve on a small scale with a small capital being invested, the industry has since evolved into a platform fi t for serious and long-term players, those who have a long-term vision as players in the domestic asset industry. 

Although there is a lot of discussion on the topic, I believe there is plenty of room for more participants. The penetration of MFs beyond the metros is still very poor, and only a fraction of investors in India include MFs in their investment options. I believe that there is abundant scope for expansion in geographies beyond the metros and the inclusion of potential investors in the long run. In the context of competition, the industry environment is quite competitive. We have old and established houses along with new participants and I believe there are still others looking to enter the asset business in India. The way ahead appears to hint at very interesting times in terms of the evolution and adaption of the industry to challenging global stimuli. 

Debt funds are not as popular as equity funds among retail investors. So as a fund management house, what are you doing to popularise the debt funds? 

Equity funds are perceived to be more vibrant and spectacular in terms of their composition and return potential. Debt funds are perceived in a more orthodox manner. Debt funds typically endeavor to protect capital and provide regular, albeit relatively lower returns. On the other hand, equity funds are typecast as wealth builders which aim to participate in the corporate growth stories. In that sense, the fundamental objectives of equity and debt funds are diff erent. The risk appetite of a debt investor is significantly lower than that of an equity investor, this basic fact should be kept in mind by debt fund managers at all points in time. 

At an operational level too, the domestic debt markets are different from the equity markets. By and large, the Indian debt markets (especially the corporate bond markets) suffer from a lack of standardisation and depth. Lack of liquidity is the most significant lacuna in debt markets. A debt fund manager, therefore, must not only manage the credit quality of the portfolio but its liquidity as well. In fact, the crisis of 2008 was actually a case of illiquidity rather than a credit meltdown. 

What has been your investment philosophy? 

The approach to debt investments is primarily guided by interest rates and their movements. Since credit risk is of primary concern, we follow a bottom-up approach for stock selection. While following a bottom-up approach to investments in debt papers, due care is taken to reduce liquidity risk and risk spreads are also evaluated to generate alpha. Further, as the debt instruments are not standardised, due care and analysis is done to understand the structure of the instruments and the risk-return potential before making an investment decision.

What is your take on the interest rate front and how do you see it panning out going forward? With the WPI and CPI coming down, how soon do you see the rate reversal happening? 

The interest rate cycle in India seems to have peaked off . With inflation appearing to be on a softening trajectory and international indicators moving sideways, it is possible that we may not see any rate action in the near future. However, with more emphasis being placed on CPI, our dependence of the monsoons as an economic indicator increases. Monsoons are a natural phenomenon and its prediction is not easy. Therefore, as CPI gains importance as a lead indicator, it becomes more difficult to project the trajectory of the interest rates with a short- term perspective. Having said that, I don’t see the rates softening in the immediate future as well. We may well see a period of interest rates remaining stable before the RBI decides to take further action. 

What is the right strategy to invest in debt funds especially in the current scenario?

As mentioned earlier, we appear to be at the beginning of a softening cycle. We are likely to experience a period of interest rate softening before rates stabilise. However, given the fact that the RBI inflation targeting inclination and its preference for CPI as the key inflation indicator, the interest rates may be more dynamically managed by RBI going forward. As a result of this, we advise retail investors to stay invested in debt funds while keeping about a quarter of their monies at the shorter end of the curve (liquid and ultra short-term funds) and venture out towards products, which are longer on the yield curve with the balance monies albeit in a calibrated manner.

The bond markets have not developed as expected. What according to you has gone wrong and what steps should the government or the RBI take to develop it? 

The Indian corporate bond market is tiny when compared to the bond markets of other nations. Corporate bonds account for only about 4 per cent of the country’s GDP, compared with 70 per cent in the US or 49 per cent in South Korea. Bond markets require risk-free benchmark yield instruments for pricing of credit risk. The country today does have a large Government securities (G-Secs) market for this purpose. This market has developed rapidly since 2000 and is resilient enough to absorb large orders without affecting price. But while government borrowings are large in terms of large and regular issuances — Rs 6.7 trillion in 2011-12 — the volumes are very poor compared to the issued stock. Not only has the turnover ratio been constant around 1x since 2004, but the top five G-Secs alone account for 86 per cent of total traded volumes. Also, benchmark risk-free yields are well established only for limited tenors, especially the most traded 10-year paper. Nor is there any great diversity in the G-Sec market participants, as 70 per cent of the stock is held by banks. The story is worse in the corporate bond space, with about 6 to 10 issuers dominating over 90 per cent of the volumes.

A lot of discussion has taken place on this topic and for a long time now we have had various proposals on the table in this matter. There are many steps that need to be taken to improve the situation and while some of the steps such as transparency in reporting of trades and dissemination of the same is already underway, some other steps such as the Forwards and OIS markets have not taken off in the expected way. A functioning Repo market for Corporate bonds is another long standing requirement which needs to be addressed. In addition, steps need to be taken to standardise corporate issuances so that they meet the needs of a larger investor base rather than serve only the requirements of the issuer. Admittedly, the issue is not as simple as it sounds as there are multi-layered regulatory and legal issues to be considered and sorted out before we can have a coherent policy of reform implemented. 

The recent step of creating a vibrant IRF market is being watched closely. This is our third attempt at developing a vibrant and deep interest rate futures market. We hope to see good progress in this space as a harbinger for further development of the Indian bond markets.

What is your advice to retail investors in the Indian markets at this juncture? 

As I mentioned earlier, we believe that we may be at the beginning of a softening interest rate cycle in India. However, with the general election coming up, the domestic and international backdrop remains dynamic. In such circumstances, I think it is a good time for investors with a medium to long-term investment horizon of say beyond six months to invest in debt instruments and products which can take advantage of the softening in interest rates. 

As said before, our economy is slowing down. But given the bleak global conditions, we may continue to outperform many other developed and developing markets. Given our long-term economic growth estimates and our long-term inflation trajectory, our medium to long-term view has an undertone of bullishness. In such market conditions, I think that for investors having a medium to long-term investment horizon of say more than six months, it is appropriate to go in for duration products such as dynamic bond funds, medium-term bond funds and PSU bond funds.