Economy Requires continued Support From Both Monetary & Fiscal Policies: Pankaj Pathak, Quantum Mutual Fund

Fixed income seems to be headed into choppy waters. Do you think rising U.S yields and inflation concerns will pose headwinds for debt investors in the medium term?
Rising global inflation is a big concern for Indian bonds over the medium term. In the US, market narrative is already shifting from ‘lower for longer’ to ‘tapering asset purchases’. The sudden change of monetary policy direction in the US is the biggest risk for the Indian bond market in 2021. 

Indian bond yields are poised to move higher albeit at a gradual pace supported by the RBI. Thus Investors with longer holding period should not worry too much about intermittent volatility.    

How about India? The RBI has been supporting yields through GSAP’s and OMO’s throughout COVID…. Is the “Das Put” due to continue? 
The Indian economy was in a process of recovery from once in a lifetime shock. Then it got hit again by the second wave of covid-19 and rounds of lockdowns across many states. The economy remains extremely fragile and requires continued support from both monetary and fiscal policies. 

The RBI might continue to support the bond markets through GSAPs and OMOs to keep interest rates at reasonable levels. However, it may allow yields to move up gradually if inflationary pressures sustain and global monetary policy direction changes.      

With the second wave of COVID striking hard, it seems that the plans to scale back easy liquidity will go on the backburner. Do you agree?
Yes. The second wave has certainly pushed the expectation of liquidity normalisation and potential rate increases further into the future. Currently, the excess liquidity is close around Rs. 4-5 trillion. This level of liquidity may continue until we see meaningful progress in economic recovery.    

Let’s talk about retail investors for a moment. Choices to earn returns from financial instruments seem so limited! Equities are at stratospheric valuations… and it seems that debt returns are going to be muted too. What’s your take? What should low risk-taking retail investors do right now?
First and foremost, investors should acknowledge that the best of bond market rally is now behind us and should lower the return expectations from fixed income products. Anchoring our expectations to past high returns could cloud our judgement and lead to undue risk-taking.  

The market could face a lot of turbulent times in the next 1-2 years. It would be prudent to keep risks under control and have a longer holding period to ride through the intermittent market volatility.   

Investors who can tolerate some short term volatility in their portfolio value and can hold their investments for a longer time period can consider a dynamic bond fund where the fund manager has the flexibility to change the portfolio when interest view changes. These funds are best suited for long term fixed income allocation goals. However, do remember that bond funds are not fixed deposits and their returns could be highly volatile and even negative in a short period of time.

Conservative investors should stick to categories like liquid funds where the impact of interest rate rise is favourable. However, while selecting a liquid fund be cautious of the credit quality and liquidity of the underlying portfolio.  

What about corporate bond funds? Is there a play there? Do you foresee some sort of spread compression happening over the next year or so…?
Corporate bonds particularly the AAA segment had a meaningful rally in the last year despite. Credit spreads on good quality corporate bonds are at a multiyear low despite weak economic performance and financial pain caused by the lockdown. 

Various measures by the RBI and the government like LTROs, credit guarantees etc. have been supportive for the segment. Going forward impact of these measures could fizzle out.  Credit spreads could widen for the AAA and AA segments of the corporate bond market.

Can we assume that you are warning investors against long term debt at the moment?
It depends on the investors holding period. Inventors with low risk appetite and short holding period should avoid all long term debt categories. We are now entering into a rising interest rate cycle. This is bad for long term debt funds as long term bond prices fall more when the market interest rate rises.

However, investors can mitigate this risk by remaining invested for a longer period to normalise the impact of interest rate cycles. Dynamic bond funds remain a good option for such long term investors.  

Any parting words of wisdom for fixed income investors right now? Especially those who rely on debt funds for their post-retirement income…
Returns on debt funds are likely to come down going forward. But investors should avoid taking undue risks to generate higher returns. Remember one can mitigate the risk of rising interest rates by having longer holding period. But there is no way to mitigate the risk of credit default. This can cause permanent damage to your portfolio. So choose funds that invest in good credit quality debt securities like government securities and public sector companies.    

While investing in a debt fund, always prioritise safety and liquidity over returns.