Sometime in November 2021, when the US Federal Reserve's policy meeting minutes showed its intention to end its easy money policy and hike interest rates, bond yields in the US and in India started to rise. Eventually, as the new year began, more fund houses started launching target maturity funds—open-ended debt funds that lock your investments at prevailing yields by buying medium- to long-term securities. The aim was to try and earn you yields when you exit the fund at the time its underlying securities mature. Target maturity funds became popular, especially towards the end of the year due to indexation benefits.
But Marzban Irani, chief investment officer, debt, LIC Mutual Fund, stayed away from target maturity funds because he wasn’t satisfied with the hike in yields. Back then, he estimated that this was just the beginning of rise in yields. That cycle of rising yields has nearly run its course now, says Irani. He has finally come around to target maturity funds and long-term debt funds. He was contrarian back then, and he is still contrarian.
In an interview with Jash Kriplani of Moneycontrol, he explains his reasons:
Central banks around the world, including the US Fed and the Reserve Bank of India (RBI), have just about begun to increase interest rates. And you’re saying that the right time to invest in duration-strategy debt funds is now. Isn’t that a bit contrarian?
Since the last two years, we have been telling investors not to invest their money in long-duration funds. A lot of target maturity funds were launched when the 10-year G-Sec yields were around 6.25 percent to 6.5 percent levels. We were telling investors to stick to liquid funds or low-duration funds, nothing beyond one year. We were expecting liquidity normalisation to start from August 2021.
We were of the view that it would be better for investors to keep the funds in liquid funds or low-duration funds to conserve capital and then deploy it when rates rise significantly.
By September, when a decent percentage of the population had received COVID-19 vaccinations, we expected the excess liquidity will be withdrawn as the economy started to open up. We thought that now there can be reversal of liquidity and interest rate hikes can be quite sharp because rates had been low for the last two years. If not a repo rate hike, we expected at least reverse repo rate hikes. The CBLO (collateralised borrowing and lending obligation, a money market instrument) had gone to as low as 3.35 percent. We at least expected a more hawkish stance in the central bank’s commentary as we were seeing by the US Fed.
But the rates have risen now and bond prices have corrected, so investors can look at long-duration funds and deploy funds in a gradual manner. Interest rates will be hiked over the next six to nine-month period. But that doesn’t mean that bond yields will also go up in a similar manner.
The repo rate is likely to be hiked gradually. It might go up to 5.5 percent-6 percent, but that doesn’t necessarily mean that the domestic G-Sec yields will go up from 7.5 percent to 8.5 percent. The (debt) markets always discounts the rate hikes in advance. So that correction has already come to a great extent.
Yields might go up further to 7.75 percent, it might even touch 7.98 percent temporarily, but it cannot sustain there for a long time. It has to decline over a period of time. If yields go to these levels, the RBI might intervene with OMOs (open market operations) as these are very psychological levels.
How do you see interest rates moving, going ahead?
We have seen aggressive rate hikes in the US. Just a few days back, the rupee crossed the 78 mark against the dollar. Now, with these kinds of aggressive rate hikes in the US, if emerging markets don’t hike rates, then there will be outflows and currency will get impacted. The RBI’s monetary policy committee (MPC) meet is in August, but there is a Fed policy again at July-end.
So, I think the RBI might not wait until August and there is a small chance that the MPC might take some rate-hike action before the US Fed’s policy meet. If the Fed takes a sharp rate hike of 75 bps (basis points) again at its July-end meet and we wait till August, we may fall behind the curve on the rate-hike cycle.
Why do emerging markets’ central banks have to hike their own key rates, when the Fed does it?
The interest rate spread between ours and US’ 10-year security is roughly 450-500 basis points. If they keep hiking rates or their yields keep going up, and the yields remain at the same levels here, this spread widens. So their market becomes more attractive for investors. To maintain this spread, central banks of emerging economies need to hike their interest rates.
How long before the inflation pressure starts to ebb?
Earlier, there was a prediction that the monsoon will be good, but it has been below normal. Depreciation of the Rupee is contributing to import inflation. Crude oil prices have gone up and India remains a net importer of crude Oil. We have also seen a heat wave this year. Food prices may shoot up because of a bad monsoon. Recently, the government announced increasing the MSP (minimum support prices) for the farmers. All these factors will drive inflation. It will not go back to 4 percent. It might decline from 7 percent-8 percent to 5 percent-6 percent, but we don’t see it going to 4 percent anytime soon.
What is your advice for investors now? There are many who have short-term goals, like parking their money for the next three to nine months or so. And there are those who wish to invest for the next three to five years but don’t wish to take much risk. Where should both these groups invest?
For investors with three to nine months’ horizon, they should invest in liquid to low-duration, depending on risk appetite. For investors having more than a three-year horizon, they should invest in the bond/gilt category depending on risk-appetite.
For long funds, 50 percent now and 50 percent by the August policy.
Target maturity funds are now a decent option. One can invest now.
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