'Dynamic Bond Funds Offer Attractive Return Possibility'

Mahendra Jajoo, Head - Fixed Income, Mirae Asset Global Investments (India) speaks to BW Businessworld on bond yields, global risks and Mirae's broad fixed income strategy for 2017-18.

What's your take on yields in the next 12-24 months? The recent volatility has left many retail investors quite unsettled…
Since the last MPC review, the three key risks factors highlighted by it have shown directional improvement. While crude oil prices went down almost 15% from recent peak before rebounding slightly now and rupee has appreciated to nearly an 18-month high, core inflation for February was down nearly 20 bps. After fed rate hike in March, global markets have also been stable. Guidance from Fed press conference was interpreted by traders as somewhat more dovish than expected. US 10Y yields which had risen to 2.60% ahead of Fed meet have since eased to 2.33%. With the defeat of a revised healthcare bill from Trump administration, apprehensions of accelerated tax cut and fiscal expansion have also been diluted, leading to reduced concern of an inflation spike in US. With predictions for a normal monsoon, inflation should remain under control. We expect RBI to continue to hold key rates on hold in first half of 2017 and expect 10yr govt bond yields to remain in the recent range of 6.55-6.95% in near term.

At this stage, what sort of modified duration should retail investors be aiming for? Do you see the duration play still having some mileage left, or are accruals the way to go?
Every investor will have his own customized need depending on investment horizon and risk preference and should consult his financial advisor. For those investors with long term horizon and ability to accept volatility, Dynamic Bond Funds in our view, offer attractive return possibility. CPI inflation, though in headline term is expected to spike somewhat in coming months, overall trajectory still remains well anchored. More important, core inflation, which has remained sticky for last year or so, has shown signs of easing slightly. Indian rupee has appreciated strongly last month on the back of record FPI flows. Indian macros are very strong and in the long term we remain constructive on Indian fixed income market. Accrual has value for investors who prefer stable but may be, lower returns. In our view, long term investors should focus on trying to maximize returns while keeping adequate safety in mind. Given the quick swings in global macro indicators and somewhat volatile political and fiscal set up in the world, we expect markets to remain highly volatile. However, we are of the view that in long term, fundamentals of Indian economy remain robust and actively managed duration funds with high quality portfolio will outperform accrual as a strategy.

What global factors do you see impacting Indian fixed income markets in 2017?
Even as the domestic economy remains strong, with increased integration with global economy and with still large dependence on overseas capital flows, Indian markets will be impacted by the events in global market. The recently elected new president in US seems to be following relatively non-conventional political agenda. Several contentious issues like, trade relationship of US with rest of major economies including China and efforts to impose fresh travel restrictions and talks of fresh tariff barriers have unnerved the global analysts. Further, rejection of a revised healthcare bill, notwithstanding majority of Republicans in both houses of US Congress has created fresh uncertainty. Alongside, while recent economic data in US has been robust, forward looking indicators are indicating a stagnating pace of economic recovery. Fresh doubts are being raised over how aggressively can Fed continue to raise rates. We believe market currently discounts a fast-paced Fed rate hike and a sharp acceleration in economic activity. Any disappointment on this front can yet again cause high volatility in global markets. Thus, Fed rate hike trajectory, global growth momentum and political developments are three key factors we shall be watching.

Do you still see opportunities in the credit space, or are they drying up fast? The number of downgrades is on the rise…
As we see it, there are two main possible opportunities that credit space potentially offers. First is higher accrual income due to higher credit spreads and secondly, benefits from spread compression in case of any rating upgrades. Recent history, as your question also suggests, indicates that the extra return on account of credit upgrades has been pretty much non-consequential in overall return from credit funds. In terms of higher accruals also, our broad understanding is that average portfolio coupons net of expenses of credit funds are again not very attractively higher, on risk adjusted basis, than that of a high-quality portfolio. In fact, a recent analysis released by CRISIL suggested that total return on high quality bond indices was broadly in line with and in some cases even higher than that of credit indices. Secondly, defaults and delays are integral to a lending business and most banks and NBFCs do factor in a certain possibility of default in pricing their lending products. That being not the case for mutual funds, being pass-through vehicles, investors should remain reconciled to such possibility of default and its consequences while taking their investment decisions. Our experience is that market risk is generally temporary and credit risk is permanent. One big default even with portfolios constructed with utmost due diligence and care can upset all expected calculations. And we think that defaults are not necessarily always bad investment decisions by the fund but an integral part of lending business. So, given recent experience, the incremental returns generated by credit space in India have not been exciting enough to deepen credit risk in the portfolio. As such, we believe that a high-quality portfolio provides much better risk adjusted returns.

What steps does the industry need to take to prevent more BILT-like scenarios that can lead to a loss of faith in even liquid funds, which are considered by many to be the proverbial safe haven?
I personally feel, mutual fund industry, in general, has done a very good job. All possible measures are mostly taken to ensure a positive and healthy experience for the investors. There have been a few unpleasant outcomes but that compares very well with other lending spaces like banks, NBFC or MFIs. There can always be such one-off situation where a fund might face a default situation. At times, it's just an unforeseen turn of events in spite of utmost care and due diligence.

There could also be stray cases where doubts can be cast on the investment process but how does one decide what is at fault? While the industry needs to put extra efforts in credit analysis, it is up to the investors and advisors to avoid funds that lack either the process or discipline to evaluate and mange credit risk appropriately. We believe regulators, industry body AMFI and individual fund houses have always gone that extra mile in creating awareness about risks of investing in mutual fund. Huge efforts have been made in trying to provide a positive and healthy experience to investors. There could be some rotten apples but its not the reason enough to loose faith in industry, as you say, but just may be enough for advisors and investors to be more judicious in choosing with whom and in what type of funds to invest ,depending on their objective and risk preference.

Broadly speaking, what would be Mirae Asset's fixed income strategy for FY 2017-18?
At this point, focus is on broadening our offerings in fixed income space . We recently launched a Dynamic Bond Fund that got very encouraging response. Specially given the market environment prevailing at the relevant time. In our Dynamic Bond Fund offering, our focus is to encourage long term investment approach with focus on maximizing returns, with a high quality portfolio and with accepting short term volatility with a long term focus. The focus equally is also on growing our fixed income AUM.