“Fixed income markets generally do well in falling interest rate scenarios”

With the current sentiment in the fixed income markets being positive, Avnish Jain, Head (Fixed Income), Canara Robeco Mutual Fund, explains in this interview the various factors that come into play and how investors should tick off certain salient points to make the most of their investments.

Could you explain the current trends in the fixed income market and how they are affecting the investors?
The current sentiment in the fixed income markets is positive. The global rate cycles seem to have peaked and the US Federal Reserve and other large central banks have been in a pause mode for past few months. There is an expectation of the global rate easing cycle to start in CY 2024, with large central banks like the US Federal Reserve, ECB and BOE expected to start cutting rates. The global rates have eased from their highs seen in 2023. Locally, the rates have trended lower as the Reserve Bank of India’s Monetary Policy Committee has been on a pause mode for FY 2024.

The RBI Monetary Policy Committee is also expected to ease in FY 2025, but the timing is likely to be in the second half of FY 2025. Investors can likely benefit from investment in fixed income markets, especially when the rates are falling. In the falling rate scenario there are expectations of capital gains (when yields fall in fixed income securities, the prices of the securities go higher), which may improve the overall returns for fixed income investors.  Investors would do well to keep this factor in mind before parking their funds.

Could you enlighten our readers, especially the new investors, on the relationship between monetary policy changes and the fixed income market?
The monetary policy is under the aegis of the RBI Monetary Policy Committee, which decides on the level of a key policy rate i.e. the repo rate. The repo rate is the key rate on the basis of which banks, financial institutions, etc. decide on their respective borrowing rates and lending rates. The RBI MPC has a mandate to keep overall CPI inflation within a band of 2-6 per cent, with 4 per cent as the desired level of inflation for consistent economic growth. Depending on the current CPI and expected CPI inflation rate, the RBI MPC can increase or decrease the repo rate.

For example, if CPI inflation is near or higher than the 6 per cent rate, the RBI MPC may increase the repo rate, which in turn increases the borrowing costs for borrowers, which in turn is expected to reduce demand and reduce inflation. On other hand, if inflation is near the 2-3 per cent rate, it is considered very low and the RBI MPC is likely to reduce the repo rate. This in turn can reduce the cost for borrowers, and in turn can lead to higher demand from consumers, and push up the level of inflation to the desired level. Fixed income market movements are strongly co-related to monetary policy action.

If expectations are of the repo rate going higher, then the overall market yields may go higher, which may lead to lower fixed income security prices and overall subdued returns. On the other hand, if there is expectation of rates going lower as in the current market conditions, then market yields tend to drop over a period of time, and security prices go higher, leading to an improvement in the overall returns from fixed income securities. Fixed income markets generally do well in falling interest rate scenarios as apart from the normal interest payments which the investor receives, security prices can go up when interest rates fall and may generate capital gains for investors as well.

How does Canara Robeco differentiate its fixed income offerings from those of its competitors?
Canara Robeco (CRAMC) follows a philosophy of quality investing wherein the investments are restricted to high credit-rated instruments in AAA or AA space. The CRAMC credit policy further avoids investments in securitised products and some high-risk sectors like real estate. CRAMC endeavours to construct high-quality portfolios in order to mitigate risk from credit events like downgrades or outright defaults which could adversely affect investor returns over the longer term.

With the upcoming Lok Sabha elections, what implications do you foresee for the fixed income market?
Fixed income markets are predominantly impacted by macroeconomic factors like inflation and growth as well as fiscal deficit of the government. If fiscal deficit is high than there is likely to be more borrowings by the government, leading to higher rates, which will, in consequence, adversely impact returns for fixed income investors. The NDA government has already announced a fiscal deficit of 5.1 per cent of GDP for FY 2025 in the interim budget, which was largely in line of the glide path to reach a fiscal target of 4.5 per cent of GDP by FY 2026.

Post elections, fixed income markets are likely to be driven by whether this number changes, in either direction, when the full budget is presented. In case the number is maintained or is lower, it is likely to be positive for the markets. In case the government presents a fiscal deficit higher than 5.1 per cent, it may adversely affect the fixed income markets. Further, in case the fiscal deficit is higher, it may impact the monetary policy decision-making, as higher fiscal could lead to higher inflation in the near term.

How do you anticipate the fixed income market in India to evolve in the next few years? Can you shed some light on the use of technology in the transition of fixed income investing?
As awareness about the need of fixed income securities in asset allocation increases, we should witness the share of individual investors in fixed income markets surge manifold. This should play a significant part in deepening the corporate bonds market in India. Given the fact that Indian debt securities are getting added in global indices, we can expect foreign portfolio investors (FPIs) to become a critical player in the Indian debt market.

So, going forward, we believe that we should witness a good balance of individual investors as well as institutional investors, both domestic as well as foreign, in our markets. This augurs well from a long-term sustainability perspective. As far as technology is concerned, most players have developed their own tools to research, predict and invest. Online markets for corporate bond trading are present on major stock exchanges such as NSE and BSE, and over time, as investor participation increases, we should see fixed income markets evolve in a liquid and vibrant market. 

What trends are currently shaping the Indian mutual fund industry, particularly in fixed income funds?
Currently, institutional investors are the dominant investors in fixed income funds as they offer multiple strategies that match their risk and liquidity requirements. Individual investors’ participation largely depends on the post-tax returns that the fixed income funds could potentially deliver over alternate fixed income products. However, as the overall size of individual wealth increases, there should be a strong demand for diversification through fixed income funds. 

What advice would you give to individuals looking to invest in fixed income securities?
Investors may look at investment in fixed income securities as a part of overall asset allocation in their respective investment portfolio. Fixed income typically may provide returns over the life of security, as there generally are yearly cash flows in the form of interest payment. This provides diversification in any investment portfolio from other riskier asset classes like equities or commodities. Investors may invest in fixed income securities considering their respective investment horizons i.e. if the investment horizon is of three years, they may consider investing in a three-year security.

Investors should further consider their risk appetite whilst investing in fixed income securities. Typically, fixed income securities have credit ratings ranging from AAA to D. AAA is the best rating while D is given to instruments who have defaulted on any payment obligations. While lower-rated securities may provide investors with higher interest rates, these securities also carry higher credit risk, which may lead to loss of capital in adverse market conditions. Investors may invest in higher-rated or lower-rated securities depending on their respective risk appetite.

Disclaimer: The opinions expressed above are personal and may not reflect the views of Dalal Street Investment Journal.