Decline in interest rates may not be linear across maturities

Duration funds,especially short-term income funds and bond funds continue to be attractive in the current market scenario with strong expectations of rate cuts going forward. We at UTI AMC have seen significant traction in our bond fund and short-term income fund over the past one year which is evident from the increased AUM assets under management of these funds. Similarly,the category wise AUM of the mutual fund industry also suggests a significant increase in AUM of debt oriented funds,particularly from the Retail and HNI segment which has grown from Rs 91,110 crore. as on September 2010 to Rs 1,55,163 till September 2012, going by AMFI data.

Whats your outlook on interest rates in 2013?

We expect interest rates to decline further,going forward. This will be driven by three key factors growth well below expectations,softening of inflation,steps to address the twin deficits by the government. However,the trend is expected to be asymmetrical. Considering there are a lot of factors playing in the economy,the decline in interest rates may not be linear across maturities and asset classes,making it a fairly challenging environment.

Which category of debt funds should investors go for in 2013?

With expectations of rate cuts and initiatives taken on the fiscal front,duration funds are expected to outperform short-term funds. We continue to suggest a mix of short-term and long-term funds over medium-term. Investors looking to invest with a time horizon of above 18 months could look at funds like the Credit Opportunities Fund,which in addition to higher accrual would also benefit from credit play.

A number of fund houses,including UTI,are launching debt funds that will invest in lower credit quality paper. Is that not a risky proposition?

While on a relative scale,the credit/income opportunity funds may appear risky,the rationale for UTI Credit Opportunities Fund is that the challenge which the conventional debt product would face over next year amid expected interest rate easing is how to manage the real returns of investors as consumer inflation continues to be sticky and high. In order to address the same,products with higher accrual could be of some utility which these funds would focus on. Moreover lack of depth in corporate debt space provides adequate opportunity to capture mis-priced credits. Investment approach of these credit/income opportunities funds would be to adequately compensate for the risk taken.

With the economic growth and corporate financial performance showing signs of bottoming out,there is an opportunity in this category. In addition,lower interest rates bode well for the Indian corporate sector and its cash flows,thus improving the credit health. In this backdrop,we see the credit cycle turning positive and some scope for rating upgrades and spread compression. Hence,in addition to duration play,certain allocation could be in a fund which focuses on credit play by investing in mispriced credit under modest credit quality. So investors with an 18 months time horizon can look at this product to diversify from simply following a duration strategy.

Has the outlook on gilts improved in the wake of the governments fiscal slippage outlined in the Budget?

The Budget has shown a significant improvement in fiscal deficit numbers and the government has undertaken steps in the past to achieve its targeted fiscal deficit. This has prompted the RBI to initiate a rate cut in its recent monetary policy review. In addition the borrowing calendar also looks positive in terms of demand-supply dynamics. That said,while rate cut expectations will keep the undertone bullish,performance of the gilt curve may turn somewhat sluggish in the near term when compared with front end corporate bonds.

From the start of this fiscal,what sort of returns have you seen?

Our debt funds have outperformed the benchmark and category average returns across categories since the beginning of this fiscal year. Funds like UTI Bond Fund and UTI Short-term Income fund have shown significant outperformance vis-à-vis category average as well as the benchmark during this period.

How are you positioning your portfolio?

While we continue to have high duration in our short/medium and long term debt funds,tactically we have reduced somewhat compared to beginning of the year. In the short-term,with two rate cuts behind us and the spread between G-Sec and corporate bonds,our bond and short-term income fund have reduced their relative G-Sec exposure,while increasing the exposure to corporate bonds in one to five years segment. As explained earlier,we will continue to take such tactical calls given the uncertain nature of data flow on the macro.

Are there indications that the credit cycle is bottoming out,looking at the broader corporate profitability trends?

The intensity of defaults and downgrades of corporate credit rating may recede from last year. However upgrade cases may also potentially decrease due to demand side pressures. In addition,we believe that the corporate profitability trends may head slightly southward due to lack of pass through of production costs. The governments approach towards fiscal austerity would dictate the fortunes of consumption sectors. Reduced pace of global liquidity might also weigh on the funding costs amid expected fall in domestic lending rates.

Do you see the stress in the corporate sector,especially for those with high leverage,continuing in the coming two-three quarters?

Most of the highly leverage sectors/companies have seen a high degree of loan restructuring,rescheduling and in some even corporate debt restructuring CDR. Few more sectors may add to the current tally in the coming quarters. Stress may resurface from infrastructure sector depending upon the degree of execution in the committed reforms in the energy space. Liquidity stress could resurface in sectors real estate and construction.

It appears that with another one or two quarters of slow growth,there will be stress in the corporate sector,especially with weak business models and very high leverage. However,there are pockets of opportunity and one needs to carry out a diligent research on companies to identify good credits.

Is the leverage position for the corporate sector as a whole improving?

System level leverage has improved in sectors like banking and NBFC where regulatory capital requirements have increased. However de-leveraging in non-financial corporates despite shelving of capital expenditure is not material as system-wide working capital requirement have increased. Monetising of assets is happening at a very gradual pace. Equity raising for non-government companies seems challenging amidst supply from PSU divestments. Hence the leverage position of corporates as a whole is not materially improving.

anil.sexpressindia.com