DSP BlackRock MF's Pankaj Sharma sees risk of interest rate reversal by RBI

In his spare time, he likes to cook for his son, and visits his home-town Nainital if he gets a break for more than two days. He used to play sports 25 years back but now he just likes watching team sports such as cricket, soccer, basketball, hockey and football (American).

Excerpts from the interview:

Q. Finance Minister Jaitley mentioned about Debt ETFs for the MF industry in the budget, what is your take on Debt ETF as a product? Do you think it will garner enough response?

A. ETF is a passive and liquidity product. To have a vibrant fixed income ETF market, there are certain pre-requisites. First, from a product construct, the underlying portfolio securities should have good liquidity from buying and selling perspective, which is difficult to achieve today as primary supply is not regular and secondary market liquidity is very restricted. Secondly from investor’s perspective, ETFs are used predominantly by asset allocators to achieve the desired exposure at low cost. Majority of the asset allocators in India are institutional investors like pension funds and insurance companies; they have in-house investment management teams and hence their preference is to construct portfolios on their own.

Today fixed income mutual funds provide a better alternative as they provide liquidity on T+1 basis as against ETFs, which have to adhere to exchange settlement cycle (T+2). Also, with the recent SEBI guidelines on Categorization and Rationalization of Mutual Fund Schemes, mutual funds provide investors clear risk boundaries.

Q. Where do you foresee 10-year yields moving in the near term?

A. In the current environment, there are uncertainties and hence there will be higher volatility in the rates market.  The recent worries have been compounded with the elevated commodity prices; especially crude oil prices.

Teething troubles on GST implementation led to uncertainty on tax revenues leading to flip – flops in government borrowing numbers. CPI prints are expected to be towards the higher end of the range. Higher crude oil and commodity prices pose a risk. There is risk on account of impact of proposed increase in Minimum Support Prices as outlined in the Union Budget as well as fiscal slippage in an election heavy period and its impact on inflation.

A brief period (February - March) of no supply in government auctions can provide some respite to yields at current levels. As the government auctions resume in April; we expect G- Sec yields to remain under pressure.

Q. What is your view on the RBI policy? Can we see a reversal in interest rates in this calendar year?

A. One can construe that the risk factors seem to outweigh the mitigating factors. Hence, status quo on rates and a neutral stance indeed reflect a balancing act from RBI.

The MPC will be data driven; the recent trends in macro-economic variables particularly slippage in fiscal deficit and rise in inflation expectations increase risks for sooner than expected reversal in interest rate stance.

Bond yields have been pricing the same and the balanced tone in the policy for now will resist hardening of yields.

Q. Do you see a shift from equity to debt because of fall in the markets?

A. Allocation to equity and fixed income should be viewed based on one’s overall asset allocation. Any strategic allocation to either of the two asset classes should ideally not be changed without consulting your financial advisor.

As far as incremental allocation to fixed income mutual funds is concerned, we continue to recommend money market funds, ultra short term funds and short term funds to optimise returns without diluting the credit and market risk profile of investments.

Q. What would be the effect of the budget's borrowing program announcements on the fixed income market?

A. Higher fiscal deficit does not augur well for interest rates. Government’s gross borrowing at Rs 6.06 trillion is in line with market expectations. Gross market borrowing as a percentage of fiscal deficit has been lowered as compared to last year. Demand for government securities emanates largely from banks, insurance companies and retirement funds as they are required to maintain statutory exposure in government securities.

Government borrowing programme bears a maturity profile of close to 14 years. Lack of appetite from banks and bunched up supply (auction) schedule will imply pressure on the government securities. Elevated yields on government securities will put pressure on other segment of the interest rates including corporate bond yields, bank lending rates and deposit rates.

Q. What asset allocation strategy do you suggest for investors?

A. Accrual, capital gains and trading are the three drivers for bond fund returns. With the reversal in rate scenario on the anvil; bond funds will have increased exposure to low duration high accrual assets. With the repo rate at 6 percent and the money market rates close to 7.50 percent; markets are pricing at least one rate hike at current levels.

Funds bearing higher allocation to money market rates and short tenor bonds would be considerably lesser exposed to volatility. This will not only help to self-correct the recent sub-par performance for the existing investors but also provide an opportunity for the fresh investments to earn higher returns without diluting the credit as well as market risk profile of the investments. Duration yields continue to look enticing with benchmark ten year yields trading close to 7.50 percent levels.