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‘Return Of Investment Matters More Than Return On Investment’

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‘Return Of Investment Matters More Than Return On Investment’
‘Return Of Investment Matters More Than Return On Investment’
Marzban Irani CIO – Fixed Income, LIC Mutual Fund Asset Management
Yagnesh Kansara - 29 August 2021

What is your view on debt markets, interest rates, and the yield curve? When can we expect a rate reversal and how does it affect debt fund prices? Should investors change their debt segment allocation?

In the August 2021 policy announcement, the Monetary Policy Committee (MPC) kept the rates unchanged in line with market expectations. However, one of the six members dissenting the accommodative stance reflects the change in thought process. Inflation projection was revised upwards and liquidity measures such as VRRR (variable rate reverse repo) auctions were announced. From October onwards, liquidity is expected to reduce as the festive season kicks in. With baby steps towards normalisation of liquidity amid higher inflation expectations, one can anticipate gradual stance reversal by the December 2021 policy meet and rate action before the end of 2022. Going forward, we expect the RBI to narrow the policy rate corridor through a reverse repo hike followed by a repo rate hike. Investors can stay invested at the shorter end of the yield curve and if the fund is running at lower maturity.

Recently there was more than one mishap in the debt fund segment. What are your views on the current credit environment? Is the environment conducive for a slightly more aggressive investor? What recourse do investors of such debt mutual funds have in case the AMC fails to repay the amount invested?

The Indian debt market has gone through a turbulent time after a series of defaults and heightened redemption pressure with instances of negative returns from debt funds. Risk is an inherent part of investing and the expectation of high returns from debt funds comes with a higher degree of risk which can result in lower-than-expected returns.

Investors should be cognizant of the fact that the prime purpose of investing in debt funds is safety and equity funds are growth. They should not expect high returns from debt funds as it comes at a risk. Companies with higher credit risk have lower credit ratings and, therefore, tend to give higher interest rates. The same shows lower the rating, the higher is the probability of default. Further, these lower-rated securities are generally illiquid in nature and therefore, are more lucrative from a yield perspective but may leave investors stuck at the time of redemption from the fund. Hence those investors should look at risk adjusted returns.

In terms of the current credit environment, the manufacturing sector has struggled with lockdowns and subdued demand for the last one and a half years after the pandemic outbreak. The credit off-take and the capex have been negligible during this time. Although the economy has just entered a nascent stage of recovery and this gradual improvement is reflected in the PMI, capacity utilisation and earnings, the positive impact on credit worthiness of the corporates is expected to be visible in the near-to-medium term. We remain cautious on the credit environment currently and watchful for any positive development in the overall credit market.

Legally, there is no recourse of high-yielding debt fund investors on the AMC as the offer document itself says that investments are subject to market risks. Therefore, any inability of AMC to pay the principal back to investors is a loss to investors only. Therefore, they are advised to choose the debt funds keeping in view all the risk factors.

What strategy does the LIC MF debt fund manager follow while investing in debt instruments? Can you discuss in brief your investment strategy for debt portfolio?

At LIC MF Debt Investment, we strongly believe that the return of investment is way more important than the return on investment. The investment philosophy for the debt fund segment focuses on safety and capital preservation while optimising returns. We practise safety, liquidity and returns (SLR Framework) in that order for all our investments. In safety, we focus on credit and default risk and ensure no principal loss to our debt fund investors. In liquidity, we focus on the ease of encashing the investments at the time of crisis and in returns, we focus on ‘Risk Adjusted Returns’ after taking into consideration all the mentioned risks. These are three pillars of investments where returns are at the base, derived from the safety and liquidity considerations.

What are the risks associated with debt fund investments? How much return one should expect from such investments?

As discussed earlier, the risk is an inherent part of investing and debt funds are no exception, there are certain risks specific to debt funds:

Credit risk in debt funds may lead to loss of principal for investors and therefore becomes a very important aspect to look at. The lower rated corporates may offer higher returns since they face dearth of funding avenues with higher chances of the downgrade. Rating downgrades indicate operating challenges and may lead to deterioration in the debt protection matrix, which further hinder the fund-raising ability of the corporate, and may end up in a default.

Liquidity risk is posed specifically to debt funds due to illiquid and shallow debt markets, with less secondary volume for lower rated securities. This can leave the investors stuck with the investment since fund houses with higher proportion of illiquid securities, may not be able to meet the redemptions.

Duration risk is linked to interest rate movements which expose debt funds to price volatility and result in adverse returns since prices of fixed income securities are inversely related to interest rate changes. Longer duration funds are more volatile than shorter duration and may result in a fall of returns in a rising interest rate scenario.

The funds managing the above risks optimally should deliver inflation adjusted returns if investors stay for the prescribed period in line with the average maturity of the fund.

What are the factors that one should keep in mind while investing in debt funds? How to choose which debt fund is best suited for the investor?

The investors are expected to analyse their fund selection criteria based on risks associated with debt funds, to avoid negative returns.

For credit risk, investors should be watchful of the fact that when a fund’s instruments are constantly getting downgraded since, as explained, constant downgrades may stop all funding avenues for the corporate and it may subsequently lead to default in the fund. Further for liquidity risk, the traded securities data available in exchange platforms can be accessed by investors to analyse the proportion of illiquid securities in the fund, before choosing it.

To optimise duration risk, the investors should stay away from exceptionally longer-duration funds in any particular category since they are more volatile than shorter-duration funds and may result in fall of returns in a rising interest rate scenario.

Most of the debt funds are classified by Sebi as per duration buckets. Investors have to choose the fund based on their risk appetite.

What are your views on target-maturity funds? Are the yields currently good enough to lock for a five-to-seven-year period?

For target maturity, the fund’s timing is important. For example, investors who invested at a yield of around 8 per cent got appreciation on MTM (mark to market) basis when yields declined. But an investor who is investing today when the yields are expected to inch upwards might face MTM loss. So, one has to be careful.

Do short-term categories like short-duration, corporate-bond, and banking, and PSU funds still continue to be the mainstay for debt investors?

We had been advising our investors to stay away from long duration products. All the categories I have  mentioned are active funds. At this time when interest rates are expected to harden, one can stay invested for three years and take indexation benefits. Also, one should check if duration is at the lower end of the band.

Can you list some of the debt funds from LIC MF stable where investors can get better returns compared to traditional bank savings products like fixed deposits?

Market-linked investments make debt funds more adaptable towards inflation and interest rate movements; thereby they may deliver better returns than FD. It further provides ease of withdrawal, unlike bank FDs which impose a penalty on premature withdrawals. Currently, in a rising interest rate scenario, investors may opt for our fund categories like liquid funds and low duration funds would perform better than traditional investments like FD. For three years and above LIC MF stable has debt funds in short term, Gilt and banking PSU categories.

FPIs have been hyperactive in Indian equities but have considerably reduced their exposure in the Indian debt market. What are the reasons? Does it impact the depth of the debt market?

Last year has been uncertain from the debt market perspective. Policy rates, inflation and growth-related uncertainties have taken a toll on the Indian debt market. Second wave of Covid and comparatively slower pace of vaccination has added to it. Further, expected gradual rise in US treasury yields have been offering better opportunities for FPIs. In addition to that, FPIs are becoming benchmark centric lately, and since Indian bonds are still not part of widely used fixed income benchmarks, it may partly back up their outward movement from Indian bonds.

What is your advice to the debt market investors?

We are on the cusp of a rising interest rate scenario, investors are advised to opt for categories like overnight fund, liquid fund, and low duration funds. The existing investors in long duration funds should stay invested for a three-year time horizon with the discipline even if they face some losses or lower than expected returns in the short term. Returns tend to normalise with longer time horizons.


yagnesh@outlookindia.com

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