'Repo rate hikes will have to wait until next year' | Economic Times

IDFC mutual fund earned the respect of debt investors by the way they handled the situation after the crisis in the debt market. Shivani Bazaz of ET Mutual Fund spoke to Suyash Chaudhary, head - fixed income at IDFC AMC, to find out how the fund house managed to win the trust of investors. Edited Interview.IDFC Mutual Fund gained huge respect among debt investors lately in the backdrop of the past troubles faced by the industry. What has been your experience?Our long-standing view has been that the risk profile of mass market investment products has to be consistent with the stage of evolution of the financial market ecosystem. On the one hand, this speaks to the liquidity in various classes of instruments in the secondary market. On the other, it has to do with the general level of appreciation amongst investors of various types of investment risks. Looked at this way one can argue that while the Indian ecosystem has come a long way especially over the past decade or so in terms of its development, there is nevertheless a time-frame that needs to be taken for the evolution. This can be expedited but not rushed. For example, the secondary market for lower- rated credits remains quite illiquid for the most part and offers inefficient price discovery. Even with all their liquidity planning and maturity laddering, open ended mutual funds may have to sometimes sell significant parts of what they hold over relatively short periods of time. Hence, liquidity in investments has to be of paramount importance. Also, from stand point of investors who may only over the past few years have started to diversify away from fixed deposits, mutual funds must be able to offer simple to understand and clearly defined products that take measured amount of risks. These considerations have driven our approach to fixed income over the years and form an integral part of our fund philosophy. Fortunately, they have served us well to navigate the significant volatility faced in markets over the past few years. Everyone talks about safety and liquidity, and you also talk about them. What is the difference in your approach?It’s always difficult to comment on what others do since one then speaks with imperfect information at hand. For that reason, let me restrict my observations only to what we do. We think about and communicate our fixed income funds in three buckets: liquidity, core, and satellite. From an investor’s standpoint this derives from how we think asset allocation within fixed income should be run. From our perspective, it helps clarify the construction of risk profiles for our various funds. Liquidity bucket is for your cash management needs, core bucket funds carry constrained amounts of duration and credit risks and are likely suitable for the majority of a conservative investor’s fixed income allocations, and satellite funds take higher credit and / or duration risks. Have you taken any special measures to ensure safety of investments?Within our overall philosophy as detailed above, we run a rigorous investment process to the best of our abilities. Under the process, and within our overarching framework, we continually evaluate our level of risk taking within the current and evolving macro- economic and credit environment. As an example, even though the macro-environment has stabilized substantially, credit spreads have fallen significantly generally speaking and this needs to be considered in investment decision making at the current juncture.Bond market is eagerly watching the RBI for cues on liquidity and rate cuts. What is your reading of the situation?The RBI has done a phenomenal job of containing financial market risks and economic growth deterioration as a consequence of the pandemic. It has done this through emphatic action and clearly defined communication and has been bold and clear headed to navigate through interpretational issues that have sprung up from time to time without causing analytical uncertainties for the market. At this point, foremost on the market’s mind is the framework for normalization of policy that the central bank may potentially take as it starts dialing back on the level of policy accommodation. First steps may already have been taken, though more towards process rather than policy normalization so far. Thus ad hoc bond market interventions have been reduced and the quantum of variable rate reverse repo (VRRR) auctions is being raised. Next steps could very well be further increase in VRRR followed by eventual normalization of the policy corridor through gradual hikes in the reverse repo rate. Repo rate hikes will have to wait until well into the next year.Do you expect any rate cuts this calendar year/ financial year? Where do you see the benchmark 10-year yield?Market is now looking for a gradual process of policy normalization rather than further easing. This is consistent with the underlying economic trends and global developments. As this process commences it is logical to expect the yield curve to lose some of the steepness that is present currently. At the same time, the long duration portion of the curve (say 10 year and beyond) will have to account for the larger than usual annual bond supply likely for the next few years at least. Given the interplay of these factors, for the foreseeable future we would still expect the curve to be steep relative to recent few years’ history, but not as steep as it is currently. Our preference for the most part is for intermediate maturity points (3 – 6) years where the carry on offer adjusted for duration risk taken seems to be the most optimal. You advise investors to choose schemes based on their investment horizon. Should investors play it safe and stick to short-term funds?To refer back to our liquidity-core-satellite bucket approach, most conservative fixed income investors should have predominant exposure to funds that run constrained amount of duration and credit risks. The relative weightage to core and satellite can be tweaked on the margin depending upon one’s view of things but extreme tactical shifts should be avoided, since this then voids the utility of an asset allocation framework. Having said that, yield curves are very steep in this cycle and while capital gains are extremely unlikely, the starting steepness of the curve should cushion somewhat against gradual rises in yields over the time ahead. This favors intermediate maturity points such as those run by short term funds. What is your advice to investors in long-term bond funds?Long-term bond funds (including active duration funds with a mandate to run longer durations) by definition belong to the satellite bucket since they are exposed to higher duration risk. So, investors should accordingly be mindful of how much exposure is being taken to such products. Measured allocation consistent with one’s underlying risk appetite will also allow for longer investment horizons since investor sensitivity to short term volatility will be accordingly lower. This is important as many times investor experiences in such funds tends to be suboptimal despite robust long run performance of the fund simply because investor participation gets reactively cut short in times of volatility.