In fixed income, capital can never be lost, unless there is a credit default. When yields go up, portfolio values go down. However, as the portfolio yield goes up, the returns get recouped gradually, said Lakshmi Iyer, chief investment officer - Debt and Head - Products at Kotak Mutual Fund.
In an interview with Sourabh Pandhare, Lakshmi Iyer said, 'In the current scenario, where we expect a stable / benign bias on interest rates, one should look at short and long duration schemes like short term funds and income/dynamic bond funds.'
1. Foreign investors have pumped nearly $11 billion in the Indian bond markets in 2015. Do you think India is the best place for foreign investors to remain bullish on debt markets in 2016?
Most certainly... Bulk of the developed world is engulfed in low/negative yield. US is on the path of increasing interest rates. In that, India still continues to be on the path of monetary accommodation. This implies potential for capital gains in Indian bonds going forward. Add to that the high yield carry available, makes India a potent destination for FII flow in 2016 as well. Currency also plays an important role in deciding a foreign investors allocation in the country. While we do expect INR to maintain a marginal depreciation bias over medium term, the RBI would likely ensure orderly movement devoid of any major shocks.
2. In money market, call money, REPO, and CBLO daily rates moved daily rates average moved southwards over the last 6 months. Will money market rates fall further in near-term? How do you see outlook for money market rates in 2016?
Given the benign inflation outlook in India, we have seen 1.25% (125 basis point) cut in benchmark (repo) rates. Overnight rates like call money, CBLO, etc tend to mirror the benchmark rates with immediate effect. Hence, we saw rates coming down through 2015. While we do expect rates to ease in 2016 as well, the pace and magnitude of rate cuts may not be as high as 2015. We have also seen RBI support liquidity though Open Market Operations (OMOs) and term repos. This would likely continue in the new year as well. Hence, we do expect money market rates to come down in 2016, albeit gradually.
3. During the last one year, 10-year benchmark G-Sec yield dropped from over 8% to near 7.8% now. How do you see movement of 10-year G-Sec yield in near-term? How do you see outlook on long-term yields in 2016?
We saw 125 basis point rate cut through 2015. While the shorter end of the yield curve broadly reflected the monetary action, the longer end yields barely reacted. To that extent, we saw muted response even In the 10yr benchmark Gsec yields. At current levels of around 7.75% on the 10yr gsec, the gap between overnight benchmark repo rate stands at 100 bps (repo at 6.75%). The gap (carry) looks too attractive to be ignored. Hence, we believe at the current levels, upside potential could outweigh the downside possibility. Having said that, the impending budget and the likely impact of the 7th pay commission etc would keep the market on tenterhook. Hence, markets would likely trade range bound in the near term. We do expect bench mark rates to be reduced by atleast 25-50bps through 2016. This would offer some leeway for yields to come down further. We expect 10 years yields to test 7.5% or lower in 2016.
4. In currency markets, rupee has depreciated by 6.4% against US dollar in last one year to 67-level. Do you think, rupee will cross level of 70 against dollar in the next year?
Currency movements in 2016 would be guided largely by dollar movements likely. With US Fed on the rate hike mode, the US dollar would continue to maintain strength. Equally important for us is the likelihood of capital flows into the country. 2015 saw healthy flow of US$ 33.9 bn through FDI and US$ 10.7 flows in debt and equity combined. We also have the FNCRB deposits coming up for maturity in mid 2016 the fate of which could swing the INR either ways. Historically, over past few years we have seldom seen back to back years of acute INR depreciation. This coupled with RBIs intent of orchestrating an orderly movement in INR, implies lesser probability of INR crossing the 70 levels in a hurry. Equally important would be to keep an eye on the Forex reserves, which act as war chest for protecting the INR. At around $350 bn of forex reserves, we have about 10 months of import cover. Typically, we have observed that if the cover dips below 8months, the INR tends to depreciate.
5. Favourable inflation has provided RBI room to lower interest rates by 125 basis points in 2015. Meanwhile, industrial production growth was positive with volatile movement in this year. In this light, how do you see outlook on growth, inflation and monetary policy in 2016?
So far, the RBIs target for inflation (CPI) has largely been met. The target for Mar 2017 has been set at 5%. Currently the CPI is at 5.4%. india has been one of the greatest beneficiary of falling commodity prices, specifically crude and gold (our 2 largest import items). While the current momentum does not indicate any significant U turn in commodities, one would need to keep an eye on the trends evolving in 2016. We are of the fastest growing economies in the world. Outlook on growth remains positive, probably under shooting the targets set. On the monetary policy front, we expect additional easing of 25-50 bps in CY 2016
6. What category of debt funds offer opportunity when interest rates are falling?
The beauty of fixed income investing is that it offers solutions across various interest rate cycles. Key is to engage with an advisor or self identify such potential avenues. In the current scenario, where we expect a stable / benign bias on interest rates, one should look at short and long duration schemes like short term funds and income/dynamic bond funds. These funds are a play on interest rates, hence may be a tad volatile compared to money market funds. For those seeking higher stability, they could look at accrual strategies which typically invest across the rating spectrum and tend to usually have a higher portfolio yield.
7. What is your advice to investors in the Indian debt markets at this juncture?
Stay patient... Stay invested... is what I would like to suggest to all investors. In fixed income, capital can never be lost, unless there is a credit default. When yields go up, portfolio values go down. However, as the portfolio yield goes up, the returns get recouped gradually. Also, it is very important to reinforce the fact that fixed income offers investment solutions to even Fixed deposit mindset investors. Key is to gain legitimate understanding through a financial advisor or through engagement with a fund house.