Liquid Funds: A Safe Haven

• With both banks and insurance companies following a buy and hold strategy and mutual funds participating at the short end of the curve, the bond market is bereft of liquidity. Fund management becomes a challenge in such an environment.

• The major area of concern in the Indian bond markets currently is the lack of liquidity. The lack of sufficient players in the bond market has a marked impact on liquidity. This lack of liquidity is felt more in the corporate bond market than in the government securities market.

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

The debt market in India is characterised by the presence of major institutional players like banks, insurance companies and mutual funds. The major players in the bond market today are banks who are essentially short- term players because of the nature of their liabilities, but due to historical reasons they have become the largest bond market participants. Banks in India follow a buy and hold strategy and generally do not invest in long-term bonds. This is the exclusive preserve of the Insurance companies which are the other major players in the bond market who mainly invest in long maturity bonds and like banks, follow a buy and hold strategy. The third player in the bond market are the mutual funds who invest in bonds across the maturity curve , but are currently having a major presence in the short end of the curve. The other players are the pension funds who are still small in comparison to the other three and the FII’s who, by regulation, are restricted in areas where they can invest.

The net result is that with both banks and insurance companies following a buy and hold strategy and with mutual funds participating at the short end of the curve, you have a bond market which is bereft of liquidity. Liquidity is defined as the ability to sell a bond without having any price impact. So fund management becomes a challenge in such an environment. Especially for mutual funds which are open-ended, then the challenge is to maintain a safe portfolio which is liquid and provides the maximum returns to the investors. Since liquidity is available in only the top ten traded securities, the fund managers tend to invest in those securities only, despite the fact that other securities are available at a discount to the most traded ones.

What has been your investment philosophy?

My investment philosophy is Safety, Liquidity and Return (SLR) in short. Without compromising on safety and liquidity, identifying avenues to garner the best return for the investors.

• Safety : Whether the investment is safe and guarantees principal protection i.e can one hope to get back the investment on the due date 

• Liquidity : Whether the investment is liquid enough, meaning, can it be sold at any given time to generate cash 

• Return : Whether the return being generated is commensurate with the risk involved

With headline CPI hovering around 8.10 per cent, core CPI at 7.92 per cent and WPI at 4.68 per cent, the RBI is maintaining the key repo rate at 8 per cent. We expect that the central bank would keep status quo in the near foreseeable future and do not see any scope for further cutting of rates. While in the period up to March 2014 we do not see any further issuances by the GOI, come April 2014 we should see the GOI coming to borrow heavily in the market. This would put upward pressure on yields. Since the central bank has been on a rate hike spree and rate hikes have a lag effect on the economy, we should not be seeing any rate reversal in the current calendar year.

Inflation has been coming down only in the past couple of months and mainly due to the fact that the volatile food and fuel prices have come down. Food prices declined due to increased supplies in the months of January and February, and oil prices have been coming down globally. But the most worrisome factor is the resilience of the core inflation in both WPI and CPI. Despite growth, as measured by GDP growth, showing a downward trend, core inflation in both the indicators has been constant to rising. So the net effect of such resilience would be maintaining a high rate by RBI in order to keep the inflation under control. So we should not expect any rate reversal action soon by the RBI. This view may cause concern to bond market traders, but that depends on the markets.

With the WPI and CPI coming down, how soon do you see the rate reversal happening?

Like I mentioned earlier, we do not see any rate reversal happening.

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

Given the current and the probable future scenario, where we do see yields moving up, the one place in the debt market where an investor can expect better than average returns are the money market, short term funds and the fixed maturity plans. Money market plans are those which invest in the short maturity instruments such as certificate of deposits, commercial paper etc. Such funds are either liquid funds, ultra short-term funds or fixed maturity plans.

Since we expect the yields to move northwards sooner, investors would do better if they cut exposure to duration and invest in short maturity funds like the ones mentioned above. This would help them to ensure that there are no market losses on the investments they make.

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?

At this juncture, the advise to retail investors would be to stay invested in the short end of the market as the risk in the current market, be it equity or debt, is far too enhanced to expect any meaningful returns in the near future. So investors should move to the safety of the short maturity debt products like liquid funds, which in the current DS scenario offer much better returns.