Long-duration funds worst hit, trend to continue

Written by Jash Kriplani | Updated: Sep 29 2013, 02:08am hrs
The RBI has given a clear indication that the markets should not harbour any hopes of rate cuts, says Amandeep Chopra, group president and head of fixed income, UTI MF. In an interview with Jash Kriplani, he said long-duration funds are likely to underperform as long as RBI continues to keep the long end of the yield curve elevated. Excerpts:

Are you surprised by RBI's hawkish stance

The signals sent by then RBI governor D Subbarao gave the impression that the liquidity tightening measures would be temporary. The market was taking comfort from the fact that the operational policy rate or the Repo Rate was still untouched. However, RBI pulled off a surprise by the hawkish stance it took in its mid-quarter review. The new governor, Raghuram Rajan, is trying to normalise the yield curve and the rates at the short end. So, we expect Margin Standing Facility (MSF) rates to come down and Repo to go up. RBI is giving a clear indication to markets that any hope of rate cuts should not be harboured.

How do you see the rate hike impacting debt funds

Markets are currently bearish. Yields have gone up across the board, especially the long end. Meanwhile, short-end yields have come off. This has impacted long-duration funds like income funds. These funds have been the worst hit. The seven-day returns have turned negative and this trend will continue. Going ahead, these funds are likely to underperform as long as RBI continues to keep the long end of the yield curve elevated. These funds would recover once RBI feels inflation is stable and decides to reprice the long-term rates.

What categories you expect to perform well

We expect short-term income funds and dynamic bond funds to do well as they can capitalise on the transition in the yield curve. We would advise investors to look at these categories.

Do you expect inflationary pressures to ease

There is a limited scope for curbing inflation. But it can decline as banks have effectively hiked their base rates, which means that consumption would take a hit. Low growth, coupled with low consumption, could bring down inflation. Apart from the rate-linked inflationary pressures, food-linked inflation should also come down due to the good monsoons. But we dont expect to see a significant fall.

How many rate hikes you expect from RBI in the current financial year

It is too early to take a call. The next RBI policy on October 29, where the central bank is expected to give its guidance, would give a clearer picture. We feel that there is a chance of two rate hikes.

Do you see a significant impact on growth

There are two ways of looking at it. Growth will not get immediately impacted because the reference rate or overnight rate is still coming down. Rates of different tenures are priced against this rate. Growth, consumption and borrowings are driven more by short-term rates as they get priced in immediately. These rates are expected to even come down further by 100 basis points.

So, do you see GDP growth picking up

The policy will bring down the effective cost of borrowing across the banking system, which would be moderately supportive of growth. The tightness-driven squeeze in demand would ease off. GDP can now be expected to grow at a marginally better pace of 4.4% from the earlier projection of 4%.

How do you see QE tapering impacting India

While the US Federal Reserve's actions will be a concern for local markets, the markets are also going to be focused on domestic structural issues like fiscal deficit and policy implementation. Addressing these issues would help in strengthening the rupee. In our view, QE tapering impact may be less than expected by the markets. There could be some marginal outflows, which can be easily addressed by measures linked to foreign currency non-resident (bank) or FCNR (B) deposit accounts.

MFs have been launching several FMPs recently. Do you expect this trend to continue

There is still some scope for FMPs to be attractive as long as the short-term yields remain high and the curve is inverted. But as the curve starts to steepen, due to reasons mentioned above, we think short-term income funds would become more popular.