Avnish Jain is head of fixed income at Canara Robeco Mutual Fund. These views were expressed on October 24, 2018, at the Morningstar Investment Conference held in Mumbai.
You've been shortening your duration on the strategies. Could you run us through your thesis behind the interest rate curve and really what went into making that strategy come down on duration?
Last year we saw the reversal of cycle and inflation started creeping up. From RBI's or MPC's point of view also, they were pretty sure that they were going to do something on rates sooner rather than later.
Earlier this year we saw the rate cycle reversing. Oil price started going up. The U.S. rates have been going up for some time, but now they were really entering a zone where it was soon to be near neutral and probably, after that, it's going to go beyond neutral rates. We saw pressure on the CAD coming in and the outflow started. All these factors pushed us into reducing duration where we didn't see much happening in duration. It was looking like the end of the easing cycle. And as global rates were going up and liquidity also was tightening globally, it was a clear sign that rates will go higher in the future and we were running low duration at least for the last 6-7 months in our funds.
Traditionally, you've always kind of remained away from the credit risk bucket. How do you view this space? Are you seeing opportunities or you prefer staying away?
I think as a house we have been away from the very low credit ones for long, and that has been the philosophy of the company. I think probably more to do with liquidity risk from our thought process, because as everybody knows, a situation like this occurs and even the AAAs are difficult to really get out of your books. Also in India we don't have a market for credit per se - a vibrant secondary market where you can trade credit. It's purely – the corporate run market is AAA and AA+ loaded and obviously, on top of that it's sovereign, where 80%-85% of the secondary market is sovereign, 15%-20% is corporate bond and that too restricted to the top PSU names or some good big houses.
On the credit side, the current situation is little worrisome because it seems at the same time everybody is trying to cut lines, which could invariably push people into trouble. But what we have seen in the past 10 years or so when we had problem in 2008 or 2013 or some credit problems in the last 2-3 years. People always have been – a lot of – 90%-95% have been able to get through this market problem and able to manage their positions. I think leverage is the issue and what we have been talking to various managements of various companies and I think they have indicated that currently their aim is to create more liquidity in their portfolios, cut down on growth plans.
RBI is providing liquidity at a reasonable rate. I think slowly then the confidence would come back that we have seen in the past crisis as well. It may take a couple of months., but it's not a very bad situation. It's just a bad situation from a sentiment perspective. We have seen a lot of credit crisis in the last couple of years, but markets had recovered fast. This time, because of the IL&FS issue, because it was a AAA and it collapsed, that created, I think, extra pressure on everybody to see that. And that is why, I think, the panic was created.
So, I think, this will wash over in the next maybe couple of months. Liquidity, RBI is providing. I think it's helping trying to also maybe nudge banks to lend more to NBFCs to see that they don't really face very acute shortage. I think that may not happen and people – even the mutual fund space, at least, the quality names I think in NBFC space are still getting money. So, I don't see a problem there in terms of redemption pressures which maybe there. So, I think, yeah, some companies may not get money, but the top quality names are still getting money on the short term.
Do you think it's probably now a point where you would start looking to increased duration in your funds?
I think we generally agree that rates on the upside are limited space because RBI also is looking at inflation as a benchmark for raising rates. From a house perspective, we expect maybe a 25 basis more this year and maybe a 25 next year sometime pushing the REPO to 7%. But beyond that, we don't see it growing. So, yeah, rates provide a good level, but I think because this maybe a longish pause, I think somewhat the RBI cycle maybe also linked to the Fed rate hiking. And once the Fed looks into a pause mode or going into a pause mode, I think that is the time when we start looking to increased duration because then it will be proceeded by a reverse cycle.
Until then, I think short-term corporate bond, especially high-quality portfolios would level for people to hide and put more there, and I think rates may be very raise-bound apart from a little bout of volatility whenever some events happen. But I think specifically government borrowing on the net basis have been coming down year-on-year. So, I think, rate on the upper side, there is very little less to go.
To an investor not looking at too much risk, would you recommend more on the shorter end of the curve?
If you're looking from a 2-3 year perspective, yeah, short-term funds where we have generally one to two-year kind of average maturities or one-and-a-half-year kind of duration.
I think considering the global risks which are there in terms of lot of happening on trade, on oil price and other things, that's a good place to really hide for some time and short-terms funds can give decent returns over next two to three years. Anybody who wants to be a little more risker, government bonds.
Over three-year period I think we will be back into maybe easing cycle globally. So, that could be a good point for investors to invest in dynamic or income funds.
