A gilt fund must never be a core holding

By Ravi Samalad |  26-05-20 | 
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Ravi Samalad is Assistant Manager - Editoral for Morningstar.in.

SUYASH CHAUDHARY, head of fixed income at IDFC AMC, has some interesting takes. One of them being that there is little evidence yet to argue for a structural long-term decline in interest rates in India.

Here we look at his views from three aspects: The macro view, what investors must be on the lookout for, and his take on certain types of funds.


Banks are still parking over Rs 7.5 trillion with the Reserve Bank of India. Why are they not lending?

One needs to make a fundamental distinction here between liquidity and risk capital.

Liquidity is abundant.

Risk capital available is insufficient with lenders on aggregate. Additionally, the expectation could be of further stress ahead given the huge growth shock that is currently underway.

This is getting reflected in relatively muted appetite for credit risk (reflected in higher credit spreads and more conservative lending standards) and market risk (reflected in much steeper yield curves).

Apart from this supply aspect, there may be an issue with credit demand as well given the current environment.

When do you think things will improve on the risk capital front?

One can look at the market for financing in three parts: external, sovereign, and domestic commercial.

From an overall external account perspective, India is relatively in a good place owing to our current account deficit shrinking considerably on the back of much weaker growth. This has significantly reduced our dependence on global capital inflow for the time being.

While the sovereign’s needs are large, they have to be ultimately supported by the central bank. This is today a globally accepted format and India should have no hesitation as well, so long as the arrangement is systematically wound down in the time ahead.

It is the domestic commercial financing market that will be the trickiest to navigate. There was already considerable stress in the system before the Covid shock. This will now be further amplified as balance sheets have to adjust to this significant growth shock. We think the recent trend of a rising wedge in both the cost and quantum of financing between the “haves” and the “have-nots” will continue in the foreseeable future.

There have been significant outflows from Foreign Portfolio Investors. What is driving them away from the Indian debt market?

The FPI outflow is due to a general rebalancing away from emerging markets and is not unique to India.

It is expected that the bulk of such rebalancing may have already been done and, barring a fresh escalation in risk aversion, should be somewhat more muted going ahead.

Do you think interest rates will go down as is evident in developed markets?

While the argument is tempting, there is little evidence yet to argue for a structural long-term decline in interest rates in India. This is happening cyclically currently as growth has collapsed. But for it to sustain structurally, India’s savings rate has to be stronger compared to its long-term financing requirements.


Given the high term spreads, what portion of the yield curve are you bullish on?

From a risk versus reward standpoint, the short end (up to 5 years) seems the most attractive. This part responds more to the current and expected policy rate as well as the liquidity conditions in the system.

Of course, this attractiveness only holds true for the best/safest part of the bond market (sovereign, quasi-sovereign, AAA).

Longer end rates are also attractively valued when looked at from a term spread perspective as well as in relation to the expected nominal growth rate of the country in the year ahead.

However, performance at the long end will also importantly depend upon whether the RBI steps up to meaningfully support the sovereign’s significantly higher borrowing requirement this year.

What must debt fund investors be aware of?

What has been generally missing over the past few years is a robust asset allocation model that focuses on not just making pro-cyclical investments (“greed bucket”) but equally also ensures a nest-egg or counter-cyclical allocation in order to provide a steady income when a financial market/growth cycle turns.

Such an allocation model gives due importance to “core” fixed income products which are low on both duration and credit risks.

In our view, this is the most important thing that debt investors need to address in their portfolio. A robust asset allocation model for investing which allocates to fixed income first and predominantly for safety and stability.

It is also very important for debt investors to focus on quality.


Credit risk funds have seen substantial outflows, with its asset base falling by more than 50% in one year. Do you see the trend of outflows continuing?

The intensity of outflow has abated after the first reaction and is likely to be more stable going ahead.

Do you expect a change in trend?

No. There is no macro rationale for investing in high yield credit strategies in such an exceptionally challenging and uncertain environment. Also, liquidity in lower rated credits has traditionally been constrained in India and is even more challenging now.

Inflows are trickling into gilt funds. Any advice for investors?

Only products that run both low duration as well as credit risk should qualify as core allocation products. Core products should form the bulk of fixed income allocations.

Gilt funds, just like credit risk funds, cannot be a core allocation product class for investors. Satellite allocations can be made to gilt funds, but these have to be for truly long-term horizons and cannot be looked at tactically.

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