Mutual Funds

Go for funds that follow accrual strategy: UTI AMC Group President

Radhika Merwin | Updated on October 14, 2018 Published on October 14, 2018

Given the hardening of interest rates, investors should avoid duration funds

While the RBI surprised the markets by not hiking rates in its recent policy, Amandeep Singh Chopra, Group President and Head of Fixed Income at UTI AMC, expects at least one rate hike this fiscal. He advises investors to go for a combination of high credit quality funds and select credit-risk funds that follow an accrual strategy.

Contrary to expectations, the RBI did not hike rates in its recent policy. What are your views on the RBI’s surprise move? Do you expect rate hikes in the coming months?

The RBI has focussed very narrowly on its mandate of inflation targeting. Many expected the RBI to factor in the transitory impact of rupee depreciation and oil price surge, on inflation. Instead, the RBI felt that the current inflation data did not show any upside risks and that rupee volatility has been moderate. Hence, it chose to just change the stance and not hike rates. We would have liked to see a rate hike. At this juncture, given that the RBI has changed its stance to ‘calibrated tightening’, we still feel that we can expect one or two rate hikes. While near-term inflation is benign, it is likely to trend up later next year. Also, there is still some uncertainty around crude prices and the rupee.

Given this scenario, where do you expect the 10-year G-Sec yield to be by the end of this fiscal?

It’s difficult to put a number on the yield at fiscal end. But since we expect the inflation to move to 5 per cent by the next fiscal, we foresee at least one rate hike. Hence, yields will move higher from current levels, provided the crude remain at existing levels. If it trends up to the $100 mark — as some market participants expect it to — we will have to review our rate-hike expectations.

What about the demand-supply dynamics of government bonds? There has been some respite after the Centre lowered its borrowing programme by ₹70,000 crore for the second half…

Lowering of the borrowing programme and the RBI announcing open-market operations (OMOs) (buying of government bonds) of ₹36,000 crore for October have offered relief to the bond markets. The demand-supply condition will remain somewhat balanced if the Centre sticks to its borrowing calendar and fiscal deficit target. But even if the domestic factors remain favourable, global trends are worrying.

To give you some perspective, over the past month, the US 10-year bond yield has gone up by 30 bps, UK 10-year yield by 26 bps and in most of the European region, it is up by 11-18 bps. Even in Japan, the 10-year yield is up by 5 bps. And the Indian bond yield has been down 3 bps over the past month. This is clearly not in sync with the global trend. With the rupee depreciating, foreign investors may pull out more funds. Hence, the net supply situation — which is well balanced as of now — may turn adverse. We have to closely monitor the movements in the global fixed-income markets over the next 3-6 months.

The recent IL&FS episode has had a big impact on the mutual fund industry. Given the sudden downgrades by rating agencies, has there been a re-think within your team on the credit-assessment processes?

Credit-risk funds have always been exposed to such risks. But this particular event has raised many questions around rating agencies. Despite their expertise and access to information, they were not able to raise red flags. While MFs also have in-house teams that undertake risk assessments, they don’t have as much access to information from companies issuing bonds as rating agencies.

From an investor’s point of view, how does one gauge the underlying risks within debt funds?

Since there is no industry standard to filter out low- and high-risk funds, it is difficult for investors to gauge the level of risk within a debt fund. Credit-risk funds, by design, carry relatively higher risks. But even within them, the risk quotient is widely different, as they are a heterogeneous bunch.

This is where the financial intermediaries play an important role as they have access to and knowledge of the underlying portfolio. But one has to understand that there will always be recurring concerns for credit-risk funds, given their inherent nature. The good part is that now there is sufficient history — in terms of downgrades and NAV losses — to analyse and pick out funds.

How has the recent events impacted your portfolio?

There could be an overhang over the next 1-2 quarters, given that the event is very recent. Some of this is also being fed by the volatility in the stock market, which is, in turn, transmitted to the bond market. So, it will gradually normalise. We have not faced any specific redemption pressure as our debt funds didn’t have any exposure to IL&FS. Also, as a fund house, we manage relatively low credit-risk portfolios in our funds.

What should investors do at this current juncture?

Investors should go for funds that follow an accrual strategy — focussing on interest receipts — rather than a duration strategy, given the hardening of interest rates. Within this, it should be a combination of high credit quality — such as treasury advantage, short-term income, or banking and PSU funds where a major portion of assets are normally in AAA/quasi-soverign bonds — and select credit-risk Funds. Within credit-risk funds, choose ones with very minimal exposure to low-rated (A and below) and unrated papers.

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