Tata Mutual Fund has taken the view that rates could firm up and has throughout maintained a conservative stance on its debt funds. Here, Murthy Nagarajan, Head of Fixed Income with the fund, shares his views on the debt markets.
What’s your view on bond yields?
Domestic rates are set to move higher over a period of time. The 10-year government security (G-Sec) bottomed out at 6.23 per cent on a closing basis, but it has spiked up to 6.8 per cent. In fact, it is liquidity which is causing a slower rise in bond yields.
Insurance companies are sitting on a lot of money which they are deploying even at lower yield.
Nationalised banks are also holding excess liquidity, which is being channelised into G-Secs.
Why do you have this view?
Last year, market yields fell sharply, mainly because of expectations of rate cut. People expected the RBI to cut rates by another 50 or 100 basis points. But now, there is no such expectation.
Our view has more to do with the global situation. For one year or so, policy rates may not be hiked in India. But inflation from global sources is already rising. Commodity prices, including metals, have been increasing. Once global central banks normalise their rates, the rates tend to move up.
We are also seeing that there is rising populism in the developed markets, which is likely to push up wages. That means higher costs and thus higher inflation. In India, we also believe the RBI may not conduct open market operations to buy bonds this year because of the strong FII flows.
As the liquidity drains out in the next one year, yields may go up.
What will be the impact of the US Fed unwinding its balance sheet on the bond markets?
Interest rates have already reacted to it in the US markets. As liquidity exits the market on Fed unwinding, the dollar may strengthen.
All along, the RBI has been expecting an outflow of foreign investments when Fed started hiking its interest rate. But the reverse has happened.
All emerging markets have received bond inflows. Foreign investors in Indian bonds have reckoned that with domestic CPI inflation at 4 per cent and inflation in the US at 2 per cent, the rupee may not depreciate too much.
Therefore, a return in the range of 7 per cent, even with mild depreciation, will still fetch them far more than the 2 per cent they are receiving back home. Their call has proved right and the rupee has actually appreciated, which has helped FII flows into bonds. With the improved confidence in the current government and the kind of credibility the RBI enjoys, the FIIs are gaining confidence to pump more money into India.
For the FIIs, the investing experience in Indian bonds has been quite good. They are also finding adequate liquidity to enter and exit Indian bond markets, especially with government securities.
Why are you restructuring and renaming the Tata Treasury Manager Fund as a Corporate Bond Fund?
Our current debt funds are focussed mainly on AAA instruments. Our running yields are relatively low. Today, most investors are looking for an alternative to bank FDs. Our aim is to provide the needed alternative. The fund will focus on accrual returns and have an average maturity between six months and two years for now. We may increase the duration, if we feel yields have topped out.
We are trying to create a portfolio that has an optimum mix of duration and accruals to get closer to the FD yield. However, we will not dilute our overall credit profile.
We plan to change allocations within this fund. The current strategy of the fund is to allocate around 60 per cent in AAA and approximately 30 per cent in AA category based on the current market condition and with an average portfolio maturity of less than two years. We are not going to chase very high yield, by going down the credit curve.
As per our current strategy we do not have investment below AA-. If your mandate allows it, there is always temptation to buy such paper to improve your yield. Overall, about 94 per cent of our assets is invested in AAA instruments, AA is about 4 per cent of our portfolio, with only the remaining in AA- papers.
What is your call on duration?
We are maintaining 4.5-5-year duration across funds. Our expectation is that yields will go up slightly.
As they top 7 per cent, we will increase the duration. We did not participate fully in the bond price rally because we did not increase our maturity too aggressively. That helped us handle the fall after March better.