Interest rate cut cycle is over: Suyash Choudhary
Thu, Apr 06, 2017
Source : Jeni Shukla, Citrus Interactive

Mr. Suyash Choudhary is Head – Fixed Income at IDFC Asset Management Company Limited. Mr. Choudhary has experience spanning of over 11 years in Fixed Income Investments. He holds a Bachelor Degree of Arts (Hons) in Economics from Delhi University, Post Graduate Diploma in Management from Indian Institute of Management, Calcutta.


In an exclusive interaction with Citrus Interactive he shares his views on the fixed income markets and talks about IDFC debt funds.


What is the positioning of the entire range of IDFC debt funds?


The way we have structured the fixed income platform maps closely with the retail audience. The predominant asset class in fixed income that Indians invest are fixed deposits (FDs). It is a Rs 100 lakh crore plus industry and clearly fixed income mutual funds are only 1/10th of the industry. So clearly when most clients think about fixed income they intuitively map it to fixed deposits.

There are 3 buckets under which you can examine fixed income funds.


1>The first bucket is Transactional where you plug liquid funds. Liquid funds are used for normal liquidity needs. It is more for transaction rather than investment purpose.


2>The second bucket is more consistent with the FD profile. Of course the mutual funds have a different risk profile and therefore should not be compared with FDs. However, for purposes of illustration, this bucket most closely mirrors FDs. Here you can place the ultra short term and short term debt funds. There are 2 variables on which you can associate risk in fixed income. One is duration (which most people intuitively understand that longer maturity comes with higher risk) and the other is credit risk. In this bucket you would typically place products which are low on volatility and low on credit risk. The bulk of the products we manage are positioned in this bucket. They are of high credit quality and positioned on various points at the short end of the yield curve. IDFC Ultra Short Term fund, IDFC SSIF – ST and IDFC SSIF – MT will fall in this bucket. The IDFC SSIF – ST fund is a predominantly AAA- rated fund with average maturity normally anchored around 2 years. In IDFC SSIF – MT the average maturity normally does not exceed 4 years. So we are capping the fund manager risk to that extent. Again here the fund is mainly AAA-rated. We have some positional products which, depending upon the shape of the yield curve, are placed. 3 to 4 years back the yield curve typically used to invert in the month of March. One year rates used to go to 9-10% or even higher and then over the course of the year those used to come down. So 3-4 years back we positioned products around the 1-year roll down, ie, in March you buy the 1-year and one year hence that expires and then next March you buy again. There you have a product called the IDFC Banking Debt Fund. It plays on the FD mentality. We did similar roll-down strategies on other parts of the yield curve. At some juncture the yield curve stopped inverting and started to steepen. So we positioned our fund IDFC Money Manager Fund – Investment Plan as the 3-year roll-down product. There currently there is a one year residual maturity. We did another 4-5 year roll-down last year because the curve between 1 and 5 was positive sloping so we thought we could take a 4.5-5 year and keep rolling it down. That has turned out to be one of the fastest growing short term debt products in the market. This is the IDFC Corporate Bond Fund. We have done some innovation on Fund of Funds also. We launched an IDFC All Seasons Bond Fund which moves amongst these funds in our basket.


3>The third bucket is, what you can call in a casual parlance as ‘FD plus’. In this the fund manager tries to beat the so-called underlying accrual by either taking on credit risk or duration risk; or both. So one needs to know that the plus can turn into a minus if the risk goes in the other direction. In this bucket we have a series of active duration funds - IDFC SSIF – IP, IDFC Dynamic and IDFC Gilt funds. We don’t believe in running long duration passive products simply because Indian fixed income investor does not really come for participation. They basically want to beat alternates available – mainly FD. The risk needs to be managed. Credit funds would come in the third bucket as well. These funds take on additional credit risk in order to deliver greater than FD returns. There is lack of liquidity in the credit market. You have to be very careful at the point of selecting a credit exposure because most likely it has to mature on your books because there is no going back. You can’t sell it unlike the interest rate risk which can be sold or hedged. Only in February of this year we launched our first credit product – IDFC Credit Opportunities Fund - which is a conservative credit positioning.  


What is your view on the interest rates going forward?


From an RBI policy standpoint we feel the interest rate cut cycle is done. We think the RBI is now on a very long hold. We have held this view for some time. In fact before the February policy we had gone very conservatively on duration across the platform. We benefitted quite a bit from that. Our sense is that RBI has tightened their macroeconomic framework because of what is happening globally. Since November globally bond yields have gone up. Inflation expectations have gone up. Therefore, it is prudent for the central bank to be conservative. So long as the currency (USD/INR) is well behaved RBI will be happy to be on hold. Through the forecasting horizon which is next year, we think the repo rate will remain at 6.25%. This throws up certain opportunities on the yield curve. Over March we have liked the so-called Spread Assets which includes corporate bonds, Uday bonds and state loans because those were available close to 7.8 – 8%. Tactically, one will get opportunities on the yield curve. Structurally, we think the interest rates are bottoming out. For bonds to perform you don’t need a rate cut. The spread assets I mentioned could see a rally without the overnight rate getting cut.


How do you see the inflation trajectory panning out?


In the first half of this financial year the inflation will be fairly well behaved. In the next few readings you will see the inflation number at 4% or less. However, two adjustments have not been made here. One is when the residual Pay Commission gets implemented there is a house rent component that will get implemented. The impact of this can be variable. In the core trajectory we have not factored that, but the RBI is likely to look through this impact. So it may not matter as far as RBI rate-setting is concerned. The other is the impact of GST on inflation. Most economists predict an impact of no more than 25 basis points. So if you remove these two effects the inflation in the first half on this financial year is quite benign. Where we will need to start to watch out for inflation is over the second half (October onwards). On an average for the financial year we think the average is going to be 4.5 – 4.6% but there may be upside biases depending on how these couple of items move.



What is your outlook on the 10 year G-sec yield range?


I would broadly look for a G-sec range of 6.7 to 7% over the next 6 months. This band can be broken on the lower side if inflation undershoots and on the upper side if inflation overshoots or global volatility picks up. It is not possible to give a deterministic view beyond 6 months as globally a lot of things could change.



Which global factors are likely to impact bond markets in the near future?


The one thing we are watching very closely is the so-called Trump Trade wherein whether there is a fiscal stimulus or tax adjustment etc that is coming in, when it comes and consequently how the Rupee behaves. It’s not the rate differential between India and the US that is the cause of worry today. Over 2003-2008 we have actually been able to sustain a much lower interest rate differential than is the case today. It’s really the USD/INR that we need to watch. If the Rupee is stable (which I think it should be) India policymakers will not have much to worry about. Indian assets including bonds should be broadly well behaved. There are 3 sets of agenda the Trump administration has. The first is fiscal stimulus. That could come as an infrastructure spending agenda and / or a tax cut agenda. Then there is another set of taxation changes which is meant to incentivize inflows into the US. If it comes as a border tax that penalizes importers and incentivizes exporters or territorial tax which incentivizes cross-border US corporate cash flow to come back into the US without any tax penalty. If that were to actually happen it could lead to a disruptive rise in the US dollar. The third set of Trump agenda is looking at re-negotiating international trade treaties which, if not executed properly will reduce global growth rate. The agenda is so ambitious and has so many parts that it will occupy the mind of the market. Then Europe will be watched too. Data over there is improving and last year after very long Europe GDP grew a tad better than US GDP. But on the other side there are a lot of political uncertainties as there a host of elections are due this year. Similarly people always love to talk about China for a variety of reasons. There is a lot of debt sitting in China and a large part of what China does influences commodity prices and hence the credit perception of a lot of companies around the world.


Which domestic factors could drive bond markets?


Domestically I don’t foresee many issues. Our macros are strong. Even if inflation were to rise we are talking about an average inflation which is still less than 5%. Our current account deficit is less than 1% of GDP. Our fiscal deficit (combined of centre and state) at 6% is high but will be coming down. Locally, you can’t argue for anything disruptive. There is political stability and people are happy with the initiatives taken by the government. Basis only local factors you can argue for a range-bound market and the 10-year G sec in a very narrow range. The only thing to watch out for will be the monsoons. Already doubts have emerged as to whether we will have a normal monsoon this year. There are chances of an El Nino. That could create a temporary rumble in the market. RBI will most likely look through it as they will look for more durable inflation impulses. It will be interesting to see if there is a structural rise in inflation in the second half of this fiscal. If that were to happen that would worry us a little.        


How do you see foreign portfolio inflows shaping up over the next year?


Foreign inflows are strong. What we lost over October-December 2016 due to global volatilities most of it has come back over January – March 2017. We have received flows in both debt and equities. As of now India is looking like a remarkably strong macro story. You have higher yields, currency is well behaved and the macro-economic factors are very good. FPIs for most part should remain invested.


How do you think the liquidity in the system will be managed?


As of now there is a massive problem of plenty. If you adjust for government cash balances the actual system liquidity is in excess of Rs 5 lakh crore today. Given that we also have strong FPI flows for now, it may take a sizeable amount of time for this liquidity to draw out. It could actually take the rest of the year before we reach a more reasonable surplus on liquidity. On its own that’s not a problem. It’s just that to some extent a distortion is happening on the yield curve. Today all sovereign rates below 1-year are dealing below the repo rate. Ideally, RBI should not be happy with this because their stated stance is neutral on liquidity. They should take measures so that the yield curve starts at the overnight rate which is 6.25%. There are some discussions that have happened on Standing Deposit Facility, for example. Let us see what the April policy brings. We will know in April how RBI responds to the massive liquidity. Our sense is that so long as overnight rates are stable and distortions are rectified, RBI should not worry much.



What is your advice for retail investors for investing in fixed income funds?


Not one size fits all. For a conservative investor bulk of the investments should be in moderate-duration AAA rated funds. This piece will give stable income with low volatility. The two things that you have to control is credit and duration risk. The remaining portfolio can be tranched with duration and credit risk – by allocating between actively managed duration funds managed by a good fund manager and  some residual in credit opportunities fund.



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