At a time when equity markets are hovering close to their all-time highs, investments into the debt market are frowned upon by retail investors. However, FIIs think otherwise and the debt market has continued to attract sizeable investment. Given the expected drop in inflation in the medium term, Sudhir Agrawal, Fund Manager (Fixed Income), UTI MF in conversation with Jinsy Mathew, shares his views on debt market and why debt is an attractive investment option as on date.
What is your near- to medium-term view on interest rates?
Our near-term view on the interest rate is positive, coming on the back of favorable CPI inflation data. We believe the upcoming October and November CPI data will move close to 5% partly because of the base effect. Also, lower commodity prices as in the case of oil helps. So, for the next two three months we do not see any concerns and hence we expect the 10-year G-sec to tend towards 8.3%.
But on a medium-term, we are slightly cautious. Post the November CPI data, we may see a 200-300 basis points rise, inching towards 7-8% by February. So, I would closely watch the month-on-month momentum of the CPI inflation. If the month-on-month average momentum stays at close to half a percent, we are on track for the RBI’s 6% inflation target (medium term). One must note that for the G-sec to meaningfully breach below 8.30 levels we need the repo rate below 8%. Unless there is a rate cut, it will be difficult for G-sec to meaningfully sustain below those levels. So, I would peg the medium term level between 8.30-8.50%
In case CPI moderates over the next three months, do you expect RBI to cut rates?
We may not see a rate cut in near future. A consistent inflation of 6% is what the RBI Governor is looking for. However, there is a concern here. At a time when the economy is expected to recover and with the consumer and business sentiment improving, there is a case of demand improving as also seen in the automobile sales figures. Hence, as volumes pick-up, manufacturers may start expecting price hikes in medium term. So, even at an elevated inflation level, the manufacturers are likely to increase prices which may add pressure on the CPI. And Rajan is cognizant of the same. Hence, we are not expecting a rate cut soon.
Why should one invest in debt market now?
For a retail investor with a two- or three-year investment horizon, the bond market remains attractive. The reason being RBI’s target on inflation along with Government’s support for the same in the form of increase in MSP by 4-6%, which should in turn help ease the CPI over medium term. However, there may be some concerns emerging in the next six to nine months on the CPI front, resulting in some volatility in the near term. Hence, investors should consider investing in short-term income funds and Income Opportunity funds with focus on accrual and lower volatility. Long-term income funds also remain a good bet with an investment horizon of 2-3 years.
What is the ideal proportion of debt that retail investors should hold in one’s portfolio?
Depending on the risk appetite, there should atleast be a 40% to 60% exposure with allocation across different debt categories like long term income fund, short term income fund or liquid fund. With a two-three year horizon its long term income fund, for a 1-2 year horizon its short term income fund and for near term liquidity requirements its liquid or ultra-short term fund.
CY13&14 was all about short term and ultra-short term fund. What do you see is the trend for CY 15?
For CY 2015, the obvious answer by most of the debt market participants will be income fund. But I would like short term income fund or a dynamic bond fund. The reason for these bets is because we believe that there will be volatility in rates in 2015 because of the CPI concerns, RBI Policy and Fed action. So, short term income fund and income opportunity funds with lower volatility look good. Dynamic bond fund is best placed to capture any short term opportunity present in the market as the inflation trajectory is not expected to be unidirectional.
How do you see the currency reacting to the expected Fed action in 2015?
To start with we may not see Fed raising rates as widely expected by mid 2015 due to global slowdown. As and when the taper comes around, Rupee is likely to experience some knee jerk reaction. All emerging markets are bound to face some currency pressure and the Rupee might see some depreciation against the Dollar but it won’t be a panic situation. We are of the view that Rupee will outperform the other emerging market currency. Another important parameter to watch will be Government’s commitment to controlling fiscal deficit and the reforms expected.
What happens if Modi fails to keep up with market expectations on the reform front?
If the new government fails to continue with expected reforms, then some selling pressure may be seen in the equity segment. From an FII perspective, debt flows are driven by their view on currency. And currency is determined largely by inflows in equity. So, rupee dynamics hold the key for the debt market direction.
There has been an unprecedented interest in Indian debt market over the last one year. How do you see the inflows into debt market going ahead?
I expect the inflows into debt market to continue as long as the Indian rupee remains stable. Currently, the G-sec limits are fully utilized. So FIIs who have missed out on G-secs are taking India exposure in form of corporate bonds which was not the case before. Also, the FIIs are taking exposure through NBFC names as well and that proves their comfort and bullish view on the India story.
What would take for FIIs to change their view on India?
There won’t be a radical change in FIIs view on Indian debt market. Early tapering by Fed and hence the subsequent outflows and its impact on Rupee to some extent may make a dent in the investor sentiment. Another possible blip can be fiscal consolidation path going weary.
