UTI mutual fund was one of the affected houses in the debt crisis that had plagued the industry over the past two years. Amandeep Chopra, Group President and Head of Fixed Income at UTI Asset Management Company (AMC) says that his team identified the gaps and has strengthened its processes. In a conversation with Vatsala Kamat, he explains how the credit issues led to a moderation in risk profiles across debt fund categories. Excerpts.
How soon will the economy bounce back? Will interest rates rise soon?
Given the V-shaped recovery from the pandemic last time, fiscal stimulus and vaccination drives in recent times, another sharp bounce back in economic growth won’t be surprising.
Globally, growth has gathered momentum. India also demonstrated last year that when lockdowns are eased, people regain confidence and there is a sharp recovery in the economy.
But inflation can rise if consumption increases and commodity prices rise. Inflation is above the comfort zone and the RBI’s target. So, it is not irrational to expect a roll-back of the easy monetary policy adopted over the last 18 months.
How would such a move impact fixed-income markets?
The current yields and swap rates indicate that markets are already pricing in a fair degree of policy normalization from the RBI. The overnight rates, which were at about 3.35 percent are moving closer to the repo rate, which is at 4 percent. And at the long-end of the curve, yields could move up by about 25 basis points. Policy normalization is expected in the same sequence as the easing that happened last year. So, the markets expect RBI to tighten liquidity and then change the repo rate.
But if inflation is sticky and RBI’s tightening is more than expected, then the entire yield curve may shift a lot more.
Should investors change their allocation within debt funds?
Last year was excellent for debt funds. Fall in rates led to double-digit returns across debt products. From liquid to bond funds, all gave great returns as they captured rate declines by way of capital appreciation.
Now, we are at the other end of the cycle and expect rates to rise.
The low fixed deposit rates will move up with benchmarks. But investors in debt funds, who gained from capital appreciation when interest rates went down, will have to focus a bit more on capital preservation or de-risking duration in fixed income portfolios.
Don’t just stay invested in long-duration funds. Move to low-duration or short-term debt schemes. Once markets realign to the new norm, investors can reallocate funds to opt for better yield-to-maturity products.
Any specific suggestions…
Allocate about 70-80 per cent of your fixed income portfolio to the ultra short-term and low-duration categories. The balance can be in more dynamically managed short-term income schemes – corporate bond or the short-term income fund categories.
How did UTI’s debt funds recover after being hit by the credit risk crisis? How has your risk evaluation changed?
The credit crisis hit many players in the industry, albeit in different magnitudes.
While asset management companies have in-house analysts, they also rely on rating agencies, auditors etc. to support their analysis. Some of the defaults were from companies that were being rated for decades.
Unfortunately, the size and scale of defaults were from highly regulated entities and large companies that had multiple levels of supervision. They were not new kids on the block or standalone proprietary firms. As for UTI, we did find gaps in our overall research methodology. Our credit scoring models, therefore, were made tighter.
We have used our learnings to develop a slightly new investment process and style.
But investors want returns. So, how does a debt fund manager outperform?
After the credit crisis, fund managers have moderated the risks that they take. Now, portfolios comprise high investment-grade securities. Increasingly, fund managers now look for investment-grade securities as well as duration and liquidity. This may continue for some time as the environment right now is risky, too. Rating agencies are more cautious, too, given that they have been through the credit cycle and the pandemic.
So, most funds are gravitating towards the same type of issuers. That would lead to similar returns across debt funds. In the meantime, the manager has to look for trading opportunities that offer value. This approach can help outperform the typical buy-and-hold oriented strategy.
However, corporate balance sheets have been tested for stress through the pandemic. So, I would actually argue that, with the present level of stability returning to the markets, you can start seeing credit risk funds coming back into favour.