'Investors Should Look At Short And Medium Term Funds'

The 10 years benchmark G-sec yields witnessed a major surge during October & November. What were the key drivers of this spike?
A combination of factors has been at work. Here at home, a bank bailout and expectations of fiscal slippage; and globally the rise of oil prices have resulted in worries about the trajectory of inflation and monetary policy. This has led to a rise in yields across the board.

Could you lend some clarity on how the 2.11 trillion bank recapitalization-package will impact the debt markets in the medium term?
Any increase in the supply of government securities - through recap bonds or expansion of the fiscal deficit - will lead to pressure on bond markets. Thus, there has been some sell-off in the recent past. Despite this increase in government debt, we expect the RBI to welcome the development. The RBI has been asking for better bank capitalisation to ensure transmission of rate cuts. Unless there is a direct and large increase in the fiscal deficit, it is unlikely that the RBI will change its course of policy – that is, the current neutral stance on rates is likely to continue. In the months to come, we would look to the final form of bank recap to determine the impact on the rates curve.

With speculation about the stimulus package underway, and the recent rise in Crude prices, do you see yields trending upwards well beyond the 7% mark?
The uncertainty on the fiscal front combined with higher oil prices have pushed up the benchmark 10-year yield above 7%. This represents about 50 bps rise since the August monetary policy where RBI cut rates. The divergence between RBI’s rate cut and the subsequent market yield increase shows the concern that the market has with the trajectory of the fisc. With expectations of fiscal stimulus in the market, we believe that yields will remain elevated and any softening would only be a tactical opportunity. Investors with a medium term view should remain invested in short to medium term bonds which are relatively insulated from any potential fiscal widening.
 
What global factors should debt fund investors be watchful of right now?
Globally, central banks have begun normalising policy. The Fed is expected to keep raising rates, while the other major central banks are expected to withdraw extraordinary accommodation. At the same time, commodity prices remain high – most recently, the rise in oil brings some inflation risks. This is very different from the situation two years ago when the fears were of global deflation risks.

Would you say the risk-reward scenario is favourable for credit risk funds right now? What should investors who have allocations to these funds be doing right now?
The credit cycle depends upon corporate earnings. Despite the jolts of demonetisation and GST, the earnings cycle appears to be looking up. On the back of this we have started seeing upgrades catch up with - and in some periods - exceed downgrades. These signs point to a more positive outlook for credit. Risks remain however; certain industries and sectors are still under pressure, and the rise in commodity prices have had an impact on profit margins. It is important to diversify and still remain invested in high quality companies in this environment.

What sort of Modified Duration should investors be aiming for at this stage? Say, if one has an 18-24-month time horizon?
Given the risks on the fiscal front and better prospects for corporate bonds, we believe that investors should look at short to medium term funds in the current environment.