With financial system being relatively constrained currently, where banks and non-banks have struggled with bad assets, one should look at AAA’s and sovereign debt, believes Suyash Choudhary, head of fixed income at IDFC Mutual Fund. In an interview with Chirag Madia, he says the role of the RBI is to ensure that significantly higher government borrowing goes through in a non-disruptive fashion. Excerpts…
What is your outlook on debt market?
The primary driver is the collapse of growth across the globe. It is estimated that even in India, the GDP growth would be in negative for this financial year.
In India, the space for a large fiscal stimulus is somewhat limited because of the already-elevated combined public sector deficit getting into the crisis. Therefore, the focus is to optimize the total stimulus that the government provides. The first stimulus has been around survival, which is as it should be. What one hears from media is that there will be a second round of stimulus coming at some point in future, which will be around maximizing the multiplier effect on growth.
So that is the fiscal aspect of policy response, there a monetary policy aspect as well. The effective overnight rates have been cut drastically which had two components: cut in repo rate and widening of repo and reverse repo rate corridor and ensuring that operating rates fall to the reverse repo rate. The RBI has also moved with confidence in non-convention monetary measures, including Operation Twist, LTROs and TLTROs.
So, the view ahead is interaction of all these factors. We also have a relatively constrained financial system where many banks and nonbanks have struggled with levels of bad assets, and therefore the view remains that one should anchor oneself to the quality part of the market which is AAA and sovereign.
We have seen many steps taken by the RBI. What action do you see RBI taking going forward?
We think from the conventional interest rates cuts and liquidity enhancement standpoint, most of the things which were needed to be done have been done by the RBI. From here, we think conventional policy will have diminishing utility. Rather, the role of RBI from here is to ensure that the significantly higher government borrowing goes through in a non-disruptive fashion. This may involve direct monetization of part of the deficit, it may involve resumption of earlier measures like OMOs or more regular Operation Twists. Also the focus should be on maintaining a strong dovish guidance, and keeping surplus liquidity in the system. I think reverse repo bottoms at around 3% which means another 35 basis points cut in this financial year is possible.
Do you foresee new wave of downgrades and defaults once moratorium is lifted by the RBI?
Remember the macro-economic backdrop for India heading into the Covid crisis: growth was already slow, the financial system had built-in stress and the fiscal resources available to stop the growth slowdown were extremely limited. Now, on top of these, comes the massive growth shock. It is inevitable that it will throw up substantial new accretion of bad assets because the stress in unprecedented. Losses of output, fall in income and jobs will also show in the credit quality down the line. So, we have to ensure that focus remains on quality while making investments.
What is your investment strategy and how do you manage risk in the debt portfolio?
While running an open-ended debt mutual fund, one must respect the nature of that vehicle which is linked to liquidity in financial markets. The portfolio construct should be such that whenever investors ask for their money back, the fund manager should be able to sell the securities and pay back to investors. To honor the redemptions on timely basis we need to have liquidity in the portfolio. However, in India we have found that so far that assets below ‘A’ rated papers have extremely low liquidity even in the best of times. So, the core part of our philosophy is to ensure having liquidity in the portfolio.
We have seen that a lot of recent investors in debt mutual funds are converts from banks fixed deposits (FDs), and therefore, their risk profile is quite conservative. This should automatically turn us towards a quality bias when constructing products for a typical fixed income investor. Within that framework one has to construct fixed income products keeping in mind requirement of investors, wherein we think bulk of allocation should go to ‘core’ products which are conservative both on duration and credit risk and a part of allocation can be towards ‘satellite’ fixed income products where one can take higher duration or credit risk. This strategy has helped us over a long period of time, and especially in the last two years.
As a fund manager what are the key concerns?
We are recently witnessing investors getting impatient with the quality part of the interest rate curve and wanting to dilute the credit quality for slightly higher returns. This is the one trend which is concerning us now. This is the time to ensure survival and make fewer mistakes rather than being adventurous on yields of investments.
Recently IDFC Bond Fund completed 20 years. What are the key lessons learnt while managing the fund across the market cycles?
A fund should outlast the fund manager, who is just the custodian for the fund. However, one cannot take this longevity for granted and the fund should be managed based on a framework. The important aspect here is to ensure the long-term success and longevity of the fund. There can be errors of judgment while managing the fund, but there cannot be grievous errors that violate the framework of the fund itself. It’s a good feeling that we could create a fund that could have this longevity.