We sense possibility of interest rates reversing: Mahindra MF's Rahul Pal

Debt markets have had to deal with an unusually high volatile period in 2018. Default by IL&FS came as a rude shock to investors parking funds in liquid and income schemes. The concerns over creditworthiness of issuers and rising interest rates had pushed debt schemes lower on investors’ radar. In an interaction with Jash Kriplani, Rahul Pal, head of fixed income at Mahindra Mutual Fund, offers his views on whether 2019 can bring some cheer to debt market investors. Edited excerpts:

Where do you see interest rates moving next year?
 

We had started sensing the possibility of interest rates reversing. However, we think rates may come down further. The fall can be quite sharp. We also think that credit spreads may also contract once we have a settled gilt curve. The 10-year gilt has rallied by around 24 basis points in December with retail inflation staying benign. The fall in crude prices has also contributed to the softening of interest rates. The yields have cumulatively fallen by around 40 basis points in the last two months. The corporate bond market has also moved lower. While a sense of risk-aversion can still be felt, money market rates have broadly been stable.

Given the various factors that could play out, how should an investor position himself on the debt side?
 

We feel that, at this moment, a mix of duration funds and credit risk plans (after assessing the underlying risk in portfolio) can help in capturing the interest rate cycle. The corporate bond spreads have seen a sharp rise in the last one year. Corporate spreads have started to look attractive; considering the long-term trends. Corporate bond spreads may start consolidating and contracting; this will provide a better risk-reward trade-off vis-a-vis the sovereigns.

Should one stick to the accrual strategy through credit funds or play duration? Should one be at the long- or short-end of the yield curve?
 

For capturing market cycles, one may be on the longer-end of the curve with a view that typical market cycles may have shortened. For a long-time horizon, credit risk funds may be a suitable option. The elevated levels of credit spreads offer a good entry point for an investor.

Is liquidity still a concern for some non-banking financial companies?
 

The tough environment seen by NBFCs in the recent past was due to a mix of liquidity issues, risk-aversion and market cycle. This led to the spreads widening for NBFCs. The situation also became aggravated due to “fear of the unknown”. 

This heightened state of risk-aversion may be abating as spreads in the short-end of the curve gradually normalise. Such normalisation may also move on to the longer-end of the yield curve.

What does an inverted yield curve on US Treasury bonds mean for the domestic bond market?
 

An inverted yield curve is deemed an outlier event for the US treasury bonds. We have seen that an inverted yield curve tends to increase the possibility of a risk-off trade and a sharp fall in US interest rates. On the domestic front, a risk-off trade would suggest a benign bond market.