In conversation with Pranay Sinha, Senior Fund Manager - Fixed Income, Nippon India Mutual Fund

In this interview, Pranay Sinha, Senior Fund Manager (Fixed Income), Nippon India Mutual Fund, throws light on the status of the Indian debt markets and how the curve will shape up in time to come

What’s your outlook on the Indian debt markets and yield curve? Do you expect high levels of volatility to persist over the next few months?

In the last one year we have seen a very sharp and one-way move in the fixed income markets across the curve. While the 10y has moved by 140 basis points in that period, the 1y point has moved by more than 200 basis points. So if we talk in terms of signals and noise we would find that last year has had very little noise and more of a one-way signal. That’s something which we expect to change going forward. Most of the known unknowns are priced in by the markets. Hence, going ahead, we will see more of two-way movement.

The ratio of signal and noise will be dominated by noise which would mean that we will see lots of volatility without any similar one-way movement in yield as we had seen the previous year. The only caveat to the above scenario is that we are treading on unknown territory in terms of the macro economic variables. Globally, in general, the dynamics of growth and inflation are unlike anything we have seen in recent times, and this adds to the unpredictability in fixed income markets. It also compels us to add a bit of caution to the view we have elucidated previously.

Can you elucidate how the impending rate hikes by the Federal Reserve will affect the Indian debt markets? 

The actions of the Federal Reserve will have significant impact on the Indian debt markets. While the Reserve Bank of India (RBI) has repeatedly stressed that it is not affected by the actions of the Federal Reserve, it must be noted that the timing of the RBI’s surprise rate hike was on the eve of the Federal Reserve’s rate meeting in which Federal Reserve itself hiked the rate by 50 bps as per expectations. The spike in inflation is a worldwide phenomenon and many of the reasons for local inflation can be attributed to this global phenomenon. As much as global central banks are guided by the same factors, their actions would follow a similar trajectory. That apart, the RBI will also avoid too much divergence from the global central banks, especially the Federal Reserve, so as not to put too much stress on the currency in an environment of macroeconomic stress.

Amid rising inflation, which categories of Debt Funds are expected to do well?  

As highlighted earlier, the debt markets are pricing in most of the negative surprises and hence the probability of any sharp movements is low. That said, due to the prevailing uncertainty on the evolution of inflation, there still exists a possibility of negative surprise. Thus, any investor of a medium to longer duration fund would do well to wait for 3-4 months when he or she would have clarity on how the data on inflation evolves and also how the RBI will react to the said data. The investor in this category should either wait or stagger his investment during this period. For now an investor should focus more on low duration funds in a similar duration bracket with an eye on increasing allocation to short-term or corporate bonds or banking or the PSU category post the next RBI policy when things are clearer.

How are you positioning your debt fund portfolios, particularly core debt categories like dynamic bond fund, corporate bond and banking and PSU funds in the current scenario?

As part of our strategy we are managing funds as per the active mandate and as per the investor communication we have for the last quarter. While the positioning has remained the same, we are getting more comfort from valuations in fixed income markets post the spike in yields after the recent RBI rate hike. We would continue to remain cautious till we have further clarity on the evolution of macroeconomic variables. We are nonetheless cognizant of the fact that the recent spike in yield has thrown up some opportunities. We therefore aim to tactically take advantage of these sporadic opportunities while strategically still leaning towards managing risk when looking at the risk-reward framework.

At present, how should a retail investor approach debt funds?

The pricing for the long bonds should be most interesting for a retail investor who is looking for allocation with a long-term horizon. If we are looking at the pricing of both 10y SDL and 30y government securities from a purely valuation perspective, the levels have been higher than the median level for the last decade. This has thus pushed those bonds in attractive territory. Over the next 3-4 months the uncertainty factor in this category will further decline post more clarity on inflation data and the RBI’s rate hike trajectory. Therefore, retail investors should look to either evaluate this category post the clarity or stagger the investments during that period.