'Longer duration funds may not be able to perform like they did last year'

A sharp rise in bond yields has kept equity markets on the edge over the past few weeks. AMANDEEP CHOPRA, group president & head of fixed income at UTI AMC tells Puneet Wadhwa in an interview that investors can look at accrual-oriented funds, like the low duration and short-term funds if the investment horizon is less than three years. Edited excerpts:

How have you been navigating the sharp rise in bond yields? What is the outlook for yields?

We have been trimming the duration across our flagship schemes so the impact of rising yields is lowered. We have been saying for some time now that we do not expect further easing by the Reserve Bank of India (RBI) and the rate cycle seems to have bottomed out without seeing RBI changing its accommodative stance anytime soon. With the onset of the second wave of Covid, the recovery is likely to be slower. Hence, RBI would support growth by maintaining the liquidity in the system.

What measures do you expect from the Reserve Bank of India (RBI) over the next few months?

The RBI has given a calibrated schedule to withdraw liquidity, which will align the short-term rates with the operative rate (reverse repo). The excess liquidity was leading to the three-month rates trading at levels well below the Reverse Repo and creating an aberration in the short-term yield curve. A gradual path will be necessary on liquidity to ensure that the borrowing calendar in fiscal 2021-22 (FY22) goes through smoothly.

Further, the second wave of Covid might prolong the normalcy to come back by a quarter or two. This is another factor that would impact the liquidity withdrawal and any change in rate stance by RBI. Yields at the shorter-end of the curve would be well supported due to liquidity in the system. The yields at the longer-end, however, might be volatile and be dependent on global factors like US treasury yield movement, crude oil price trajectory and domestic factors like inflation trajectory, RBI view and stance on rates etc.

How much of the commodity price surge are the financial markets penciling in right now?

With the global economy recovering and renewed demand has seen most commodity prices return to pre-COVID levels. The commodity price rise has been one of the drivers of increase in inflation and is spilling over into input price pressures. This is mostly reflected in the bond yields. From here on, it appears that an increase in supply is likely to keep the rise in prices in check. However, it is more important to focus on core inflation as manufacturers increase prices and raise inflationary expectations.

Given the current circumstances, how can bond investors approach the debt markets?

Investors should stay true to their asset-allocation for investing for long-term goals. They may look at accrual-oriented funds, like the low duration and short-term funds if the investment horizon is less than three years. The three-month to 5-year curve is steep and offers a good spread for investors who move up the maturity buckets. The longer-duration funds may not be able to perform like they did last year as they and the markets adjusts to higher rates.

Do you see more pressure on the rupee over the next few months in case foreign flows start to reverse?

We have seen record dollar reserves on the back of recent FII inflows coupled with RBI intervening in the forex markets to keep the exports competitive. Therefore, it should act as a cushion in case there are outflows in days ahead.

Do you see more outflows from the debt category as we head deeper into 2021?

On the credit front, the worst seems to be over as the credit ratio (upgrades to downgrades) inches closer to 1 (one) between October and February this fiscal, reports suggest. This year, we have seen traction in accrual oriented categories and funds having a high quality portfolio viz. Ultra-short term, low duration, short term, corporate bond and banking and PSU Fund. The momentum should continue in these categories as accrual strategy is likely to be preferred by investors over duration strategy, as we expect an extended pause on rates by RBI while keeping an accommodative stance.

Will the markets be able to absorb the government’s borrowing programme for FY22?

The budget has clearly targeted growth with a strong fiscal stimulus. The fiscal deficit numbers for FY21-22 (BE - 6.8 per cent) are much higher than the market expectations of 5.5 per cent and have created concern among market participants as there doesn’t seem to be that level of demand among local investors. It is unlikely at the present juncture to see that the foreign portfolio investors (FPIs) will create additional demand in FY22. This has already led to the yield curve shifting up. The market has been able to absorb gross borrowings of around Rs 12.28 trillion so far in FY21 only with the help of RBI and are relying on RBI to support the borrowing calendar next year as well. Markets will be closely watching the actions of RBI around the auctions to determine the direction of the yields.

US treasury yields are rising at a time when there is inflation risk as well due to uptick in commodity prices. Do you see a more coordinated action by global central banks to check this?

The global economic outlook has improved significantly over 2020 with most lead indicators rising. The benefits of a fast roll-out of vaccination has further improved this outlook and market sentiment. The combination of aggressive fiscal stimuli and central bank easing could lead to some inflationary fears as well. This has led to a generalised rise in global bond yields anticipating withdrawal of accommodation by the US Federal Reserve and other central banks. So while the rate cycle bottomed out last year, the central bank support on liquidity and bond-buybacks will ease gradually into 2022. This is the new reality that the markets are adjusting to with the US 10-year at 1.77 per cent from a low of 0.51 per cent, however, note that it is still below the pre-pandemic levels of 1.8 – 2 per cent.