Interest rates are likely to remain range bound

Interview

 When the protected mutual funds industry was thrown open to private invasion in the early 1990s, Sun F&C Asset Management was one of the first to enthusiastically set up a fund house in the country.

 Today, the well-known house manages assets worth Rs 800 crore, spread over six domestic funds and two offshore funds. Its domestic funds include three equity funds, a balanced fund, a monthly income plan and a bond fund.

 Most of its funds have been market performers. For the past three years ending February 2002, its maiden equity fund, Sun F&C Value fund, reported a return of 7.49 per cent, compared with an average of 6.65 per cent for equity funds.

 With badly scarred investors still refusing to trust technology stocks, its Emerging Technologies fund, however, shed around 33 per cent. Its debt funds, however, ended the year on a more positive note.

 Its Money Value bond fund posted a return of 15.90 per cent, against the category average of 14.83 per cent while the Monthly Income Plan, performed well too, delivering a 12.75 per cent gain to investors.

 Debt fund manager Milind Nandurkar spoke to Kripa Mahalingam and Indira Vergis on the factors that seem likely to affect the fortunes of debt funds in the next few months.

 <b>Debt funds and interest rates. You can't talk about one without mentioning the other. What's your take on interest rates?</b>

 This year, I think, interest rates are likely to remain range bound. Last year, we saw 300- basis points fall in the benchmark10-year government paper. There were three main reasons for this: high liquidity in the domestic money markets, a fall in international rates and a slip in domestic economic performance because of which credit off-take remained low. Going forward, I don't think we will face any major liquidity problem in the next six months.

 However, international rates seem to have bottomed out and look unlikely to decline further. In fact, we may well see interest rates climbing in coming months.

 Since our bond markets reacted every time there was a cut abroad (the anticipation of a domestic cut grew stronger every time), it's clear that we benefited from these successive cuts. But now we should also be prepared to take the downside if rates start to move higher.

 In addition, our inflation rate seems to have bottomed out and with world crude prices starting to move up, the "inflation" outlook doesn't look as positive as the previous year. Therefore, it may no longer be a "one-way" market this year, as far as interest rates are concerned.

 <b>When do you see an interest rate cut taking place and do you expect the credit policy to provide any signals?</b>

 We do expect a cut in the cash reserve ratio (CRR) and the bank rate sometime soon. But it's difficult to predict the timing. The announcements could come as part of the credit policy. We expect a half a per cent cut in the bank rate.

 Already the central bank has said that the CRR will be brought down to 3.0 per cent eventually. Perhaps they will announce a time-table for that in the credit policy. In addition, we also expect some exemptions on CRR to be done away with.

 However, the market has discounted all these factors. Because of this, they really don't have much more to look forward to, so it seems likely that we will not witness a substantial price appreciation in the next fiscal.

 <b>Do you expect the recent changes in dividend policy to adversely affect inflows into debt funds?</b>

 Not really. From an investor's viewpoint, yes, it will be less beneficial to invest in debt funds this year. However, when one compares debt funds with the alternative avenues available, they still seem capable of generating superior returns, even without fiscal incentives.

 True, fiscal incentives were a key reason why debt funds shot into the limelight - the differential between their post-tax returns and those of other investment avenues were substantial.

 Going forward, this differential may come down, but debt funds will still be more likely to outperform other investments because of the various advantages they enjoy: an actively managed portfolio, diversification and liquidity.

 <b>Your fund house has been the first to announce the launch of a fund to invest in rated securities overseas. Tell us about the risks and benefits associated with investing abroad.</b>

 One of the few  positive developments that came out of the budget was to allow mutual funds to invest in rated papers overseas. We expect the Securities and Exchange Board of India to issue guidelines shortly. 

 The chance to invest overseas gives you an opportunity to access better credit quality paper and enhance the diversification of your portfolio.

 While the yield levels in developed countries are lower, the forward rates are much higher. This means that the forward yield curve lies above the term money market curve and allows for more profitability.

 The main risk we take here is the currency risk. But since the rupee is a depreciating currency and we are investing in dollars, this risk usually works in our favour. It's a risk we are willing to take.

 Investing in dollars can give higher returns, either on a forward cover or normal basis. The foreign exchange risk can be mitigated by taking out a forward cover; in addition, it will also tell you your exact return in rupees.

 <b>Given the view on interest rates, what changes are you making to your portfolio strategy?</b>

 This year, we will be more conservative. Last year, debt funds remained fully invested for most of the time. This year, you will see funds move in and out of cash frequently.

 Profit-booking was not aggressive last year, because the chances were quite high that if you booked profits, you may have to re-invest later at a much higher price.

 This year, it will make more sense to book profits when the markets run up. A buy-and- hold strategy is not likely to pay off this year. Portfoliowise, it's not very advisable to go long.

 One has to be more cautious while building a portfolio this year. We are looking at maintaining shorter durations compared with last year.

 We will be also be reducing our exposure to government securities and increasing our corporate bonds exposure in the next fiscal. I believe that, this year, there will be a greater emphasis on corporate spreads.

 Since we will not be following a buy-and-hold strategy, liquidity  of the security will be very important to us. Therefore, we will be concentrating more on triple A-rated securities.

 <b>Are there any plans to launch new funds, apart from the fund for overseas papers?</b>

 We are planning to launch a fixed-income fund soon. The objective will be to cater to the needs of investors with varying investment horizons - short, medium and long term - but still seek stable returns.

 What is unique about the scheme is that it gives investors an option to design and construct their portfolio to suit their investment horizon.

 And it can also be rebalanced periodically, according to their instructions. We are also looking at launching a gilts fund this year.