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Expect 50 basis point rate cut through 2016: Lakshmi Iyer
Mon, Mar 21, 2016
Source : Jeni Shukla, Citrus Interactive

Ms. Lakshmi Iyer is the Chief Investment Officer of Debt and Head of Products at Kotak Mahindra Asset Management Company Limited, and was previously a Senior Vice President, Head of Fixed Income Products, Portfolio Specialist, and Fund Manager. She joined the firm on November 1, 1999. From 1999 to 2006, Ms. Iyer was responsible for credit research as well as deal execution, managing fund performance across all debt funds, and assisting sales in client interaction. From September 2006 till September 2008, she was Heading Products where her primary responsibilities were product related initiatives, product pricing, and coordinating with the funds management and sales team. Since September 2008, Ms. Iyer is heading the fixed income and products team. Prior to this, from November 1997 to October 1999, she served at Credence Analytics Pvt Ltd. as a Research Analyst, where she was tracking corporate bond markets in India and generating research reports. Ms. Iyer holds a D.B.M. from Narsee Monjee Institute of Management Studies.

In an exclusive interaction with Citrus Interactive she shares her views on her fund philosophy and the market.

What is your outlook on interest rates and RBI action going forward?

The genesis to that is the fiscal deficit number was on target. Also recently the CPI number has come at 5.18% which is benign. IIP is a lagged indicator but it has also been negative. These factors pave way for an interest rate cut in April or even before that. Since the RBI Policy date is not too far we might see it happening on 5th April. Cumulatively we expect a 50 basis point rate cut through 2016. If we are very lucky we will get to see the whole of it in the next policy review. But 25 basis points looks more likely on 5th April. Another rate cut might happen once we get a better sense of the monsoon. If La Nina effect plays we might see a good monsoon and food inflation may not be an issue. Probably 25 basis point rate cut is already discounted in the current 10-year benchmark yields. However, There is still some juice left in the longer end of the yield curve.

 

Which is the most attractive debt category in the current market scenario?

There is no straight answer to this. In 2016, in terms of returns, the duration funds could turn out to be the better performing category in the fixed income pack. However, if we talk about risk-adjusted return I will go in favour of short term/accrual funds which inherently have a duration like a short term fund (1 to 2 years) and have a visibly higher yield to maturity at the portfolio level (ranging from 1.5 to 2.5% over a AAA portfolio). We recommend that if you have Rs. 100 to invest Rs. 70-75 should go into the high yield accrual space/short term category and the remaining in the duration category. The reason is some part of the rate cute effect is already reflecting in the yields and in case our view goes wrong the 70-75% portion gives stability to the portfolio.

 

What kind of returns can a debt investor expect with a 3 year horizon?

The yardstick is how much an investor can make above fixed deposits. With yields coming down FD rates will also come down but a debt mutual fund investor will likely get better returns due to lowering of yields (capital gains). Over the next 18-24 months and even beyond there is a very high case to do reasonably superior risk-adjusted returns compared to tax free bonds. Even if there is one bad year in terms of interest rates (for instance, 2009 or 2013) it usually evens out over a 3-year time frame.

 

How have you positioned your debt funds?

We have only one product in each fixed income category. We have only one bond fund - Kotak Bond Fund is actively managed. The Kotak Gilt – Invest Fund is a long duration G-sec fund. Both these funds have a higher average maturity. Kotak Income Opportunities Fund is in the high accrual space. Kotak Medium Term Fund is a mix of high quality bonds and non-AAA rated bonds. This fund has a minimum of 3 years maturity. Kotak Bond – Short Term is low on maturity and cannot go beyond 3 years of maturity. So the positioning of each product is very unique in its own peer set. Kotak Corporate Bond Fund cannot buy any G-secs in the portfolio. The funds should stand the test of time and should not be held ransom to any one particular style or bias of a portfolio manager. The processes and limits for each fund are cast in stone which quarantines the risk. An investor investing in any of the funds knows the level of risk before entering. The fund manager has to manage his view within the mandate.

 

Where is the 10-year Government bond yield headed?

If the overnight rates settle in at 6.25% by end of this year we are talking about a 50 basis point downward movement. The 10-year from 7.8% levels is already close to 7.6%. So we have already seen a 20 basis point rally in anticipation of a rate cut. My sense is there could be 20-25 basis point more downward movement of yields from here. There are chances the current 10-year benchmark may reach 7.25 to 7.5% by end of the year. Incrementally we see benchmark yields going down about 20-30 bps and also a possibility of bull flattening of the curve.

 

FIIs were net sellers in debt markets in February. What is the impact?

Some of the deals and structures were maturing around that time which was part of the reason for selling. They may not have wanted to renew the structures as there was uncertainty before the Budget and concerns over fiscal deficit.

In terms of impact, when there is FII selling in the debt market or equity market there is pressure on the Rupee. In the bond market there is perception that there is no demand and hence yields go up. Hence, we need to keep track of these numbers. FII inflow is moderated. Today, as we speak the G-sec limits are full and new inflows are on auction-basis. Every auction has been successfully taken out. The corporate bond limit close to $ 12 billion is still open. In general some days back there were concerns on broader Asian markets. Because of global factors there has been general apathy towards even Indian yields.

After Indonesia, India has the highest interest rates in the world. That is a magnetic pull for foreign investors. So the inflows may continue barring these intermittent pauses.

 

What is your view on the series of corporate bond downgrades we are seeing?

Investors must understand that a downgrade is not equivalent to a default. Downgrade is a function of the economic cycle and the sector specific cycle. In the current environment some sectors are going through a bad phase because of global factors. If I give you a basket of grapes and if you have 2 of them which turn out to be sour doesn’t imply the others are sour too. Over the past 14-15 years it is seen that the probability of a AA- paper going into Default category is 0.03%. The probability of an A+ bond going down to Default category is 0.06% as per a study by Crisil. When the economy is in boom we also see upgrades. So we should not get carried away by these events. These are isolated cases. Also it is wrong to assume that banking sector problems are equal to mutual fund problems. The kind of credit exposure taken by banking sector is typically much lower on the credit rating radar compared to the aggregate of mutual fund industry. I believe that this is an opportunity. Only 2 sentiments play while taking investment decisions – greed and fear. Right now there is heightened fear in the market. This is a fantastic opportunity to be able to acquire quality assets in the non-AAA rated space with yields that adequately reflect the risk. Earlier, because there was a problem of plenty there was a tendency of mispricing credit. Today this is not happening as there are lesser buyers in the market. It is a buyer’s market. We are getting good quality assets at reasonable prices.

In recent cases where there has been a fall in the NAV of some debt mutual funds due to credit downgrades. But on a 2 or 3 years return basis the impact is not that much in such cases. Investors should not get carried away by recency bias.

There is still case to own this category in your portfolio

 

What is the lowest credit rating as per the mandate in Kotak AMC?

We do not go below A- rated papers. If we need to we need Board approval for such cases. Bulk of our portfolio in non-AAA is fulcrumed around AA and AA-.
 
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