Current macroeconomic environment can be defined by four triggers
Tue, Aug 27, 2013
Source : Jeni Shukla, Citrus Interactive

Suyash Choudhary is the Head of Fixed Income at IDFC Asset Management. Previously he was Head of Fund Management, Fixed Income at HSBC Asset Management (India) Pvt Ltd wherein he was responsible for investments of all fixed income funds. In his previous assignment at Standard Chartered Asset Management Co. Pvt. Ltd. he was designated as fund manager before which he started his career at Deutsche Bank in Mumbai. He has done BA (Hons) Economics from Delhi University and PGDM from IIM Calcutta.

Long term debt fund managed by Suyash such as IDFC G Sec-Invest, IDFC Dynamic Bond Fund and IDFC SSIF -Invest have a consistent track record and have been the among the best performing at a time when debt markets have been volatile. We get his views on some of the important aspects of fund management, his view on interest rates and the RBI policy.

Why have RBI’s measures not managed to control the volatility in Rupee?

It’s a host of factors: one, the sentiment with respect to Emerging Markets has taken a new let down over the last few days. The Dollar has risen again against Asian currencies. There have been bond sell-offs in various markets across Asia. We have participated in that. Two, the market was expecting capital garnering measures announced by the Finance Minister to be more robust. Although he has committed himself to keep the Current Account Deficit at USD 70 billion which in itself is commendable, it is a medium term objective. The market was specifically looking for credible moves to ensure near-term Dollar supply. Third, there were some possible misinterpretations with regard to the last set of RBI measures on capping the corporate and resident capital outflows. The misinterpretation was that we are heading towards capital controls, which was clarified later by policymakers. However, the overall feeling that lingers is that cohesiveness is lacking in policy. The two things that the market would have looked for is send a large structural signal say by hiking diesel prices by a substantial amount and follow it up by a significant move to bring in capital. This could be done by NRI bonds, for instance.

The long duration debt funds from IDFC have clearly outperformed their peers even in this volatile market. Is it because of you getting your calls right as a fund manager or the process?

In our case, I think the process has helped. The process looks at the underlying macroeconomic triggers first. We do not get excessively bothered by very short-term movements in interest rates if it is contradictory to our underlying structural or medium term seasonal trends. A case in point is that markets saw a very large rally in May and June this year. We chose not to participate fully in that, hence we underperformed in these months. The rationale was that the market was only focused on the bullish trigger of low growth and low inflation whereas almost completely ignoring the bearish trigger of external account vulnerability and potential fiscal risks. Hence we chose to run conservative portfolios in the dynamic and income category with 4 years maturity and close to 50% cash. When the bond prices started reflecting external account risks, we started investing the cash and increasing duration.

The bond yield reached a level close to its peak of 2008 level recently – when it closed at 9.24% on 19 August. Do you see the bond yield touching double digits? 

No. If one looks at the backdrop of why we reached 9.24%, it happened very sharply over just 2 to 3 trading sessions. The RBI’s first set of measures aimed at increasing the carrying cost of INR by increasing call rates to 10.25% were perceived to be step one, to be followed by the Government and RBI announcing measures to get capital flows. So the market’s expectations with respect to the dollar flow measures that will get announced by the Finance Minister were somewhat disappointed. The market reaction got exaggerated due to global emerging market sell-off that happened in that phase particularly. With RBI stepping in to ensure that the long-end of the curve does not bear the brunt of these measures, we do not expect us to go back to such high levels of yield. Our medium term view is quite bullish.

How did you re-align your portfolios after the RBI’s announcement of its liquidity tightening measures?

We were preparing for heightened volatility by being largely in cash. Although we never expected such drastic measures, the call was that if the bond curve is under-pricing a set of risks then we were happy to reduce participation. The only incremental change that we made was that we sold a bit of the front-end bonds subsequent to the announcement of the RBI measures. Such measures are generally aimed at massive inversion of the yield curve. Having generated a bit of further cash we then gradually started buying government bonds – which we have been doing over the last few weeks.

We have witnessed the RBI change its monetary policy stance from liquidity tightening to monetary easing within a month. What is the reason?

Unlike previous episodes, Open Market Operations (OMOs) this time around are not meant to infuse liquidity. The OMO programme conducted by RBI every year since 2009 has been with a specific mandate to enhance liquidity in the banking system in order to keep liquidity deficit within a target zone. The current OMO announced by RBI is specifically to protect longer end yields from rising sharply. The intent of the RBI was to enhance front-end rates and thereby mount a defense on the currency. Possibly, what was under-appreciated was that it is plain that the long-end of the curve will have to bear the brunt as well. With funding costs going to 10.25%, banks being very large investors into the government bond market completely went out of the market. The recent measures taken by the RBI around OMOs, HTM transfers etc clearly meant capping long-end bond yields and reducing the pain of mark-to-market for banks. An underlying concern we have with all of this is that the policy doesn’t seem very cohesive. It seems to be a series of small, incremental steps which are not necessarily tying together.

What changes do you expect in the RBI stance now that Raghuram Rajan is set to take the position of RBI Governor?

I do not expect the direction of RBI to change. Raghuram Rajan will definitely bring a better international experience than what resides currently in the RBI. Given that many of our current problems are linked to the world it would be a clear value-add. He also brings enormous credibility on the table. We really look forward to him being at the helm.

What is your view on the interest rates in the next 1 year?

From here we are reasonably bullish. The current macroeconomic environment can be defined by four triggers – the first one being Growth vs. Inflation. Although there are near term pressures on inflation, the medium term outlook is quite benign. Growth downturn is very vicious. Growth has reached a level which is likely to be a cause of great concern for policymakers. The second trigger is Credit growth. In an environment of low credit growth, banks have been happy buyers of government bonds, which is a bullish trigger. The third and fourth triggers – external account and fiscal deficit – are bearish. At this juncture the focus is entirely on the bearish trigger of current account risks. We feel that the yield curve is appropriately pricing future risks. 

Which debt categories can investors invest in from a 3-month, 6-month, 1 year and 2 year time horizon?

We repeatedly tell investors that having a longer investment horizon, does not necessarily imply that you invest in a long-term bond fund. The product selection should be a function of the risk appetite. An income fund should never be chosen for an investment horizon lesser than one year. However, that does not mean that all one year plus horizon investors should come to income funds. Investors with a lower risk appetite should opt for short-term or medium-term even with longer investment horizon in mind. Those who can take risks can go for long duration mandate products like income, dynamic or gilt funds for a horizon of more than one year.

Why has IDFC not entered the Credit Opportunities space? Do you take credit calls in the existing funds?

We do not take credit calls. There are a few reasons for that. Firstly, there is no means of hedging credit risk in India. Unlike developed markets where one can buy and sell credit protection, in India one is pretty much stuck with a credit once it is bought. Secondly, there is absence of liquidity in the credit market. If your outlook on a lower-rated credit becomes worse there is no secondary market that you can liquidate it in. Thirdly, we believe that the way credit strategies are explained to the end investor lack something. Typically these products are bought without full understanding of the consequences should a credit event strike. Hence, in our view, Indian financial markets are not developed enough to sell credit strategies to mass investors in a reasonable manner.

Do you think enough is being done to control the Current Account Deficit and the Finance Minister will achieve his target?

I would think the target is achievable. We have seen a significant correction in the trade deficit. One of the reasons is that we are seeing a rebound in exports which again could be a function of the delayed Rupee depreciation catching up and some bit of upturn in demand from US and Europe.


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