WF: Despite 125 bps rate cuts in 2015, G-Sec yields are back where they were before these rate cuts. Why is this happening?
Sivakumar: The bond markets have been worried on 2 accounts. The first being the global sell-off in risk assets that has impacted EM bonds and currencies and is impacting local sentiment. Secondly, the bond market has seen a demand-supply mismatch as demand remains weak even as issuance remains high. The states have seen a significant increase in deficit this year despite the higher tax devolution (14th Finance Commission). The market is also apprehensive about likely direction of the fiscal policy - specifically the potential deviation from the fiscal consolidation roadmap. Clarity on this account is expected to emerge when the union budget is presented at the end of the month.
WF: How has the yield curve moved over the last 12 months? What opportunities arise from this? Which segments of the fixed income market have got adversely affected as a consequence?
Sivakumar: As discussed above, at the long end, yields remain similar to where they were 12 months ago despite the rate cuts that we have seen. In fact beyond the 10-year segment yields are higher than the year ago levels. This may present a great opportunity for investors as the current spreads are too high - relative to historical averages and also given where we are on the interest rate cycle - and should normalize going forward. At the short end, initially yields had reacted to the rate cuts, however over the last few months, as a result of extremely tight liquidity conditions, yields have moved up substantially. Short end yields should normalize over the next 3-6 months as liquidity normalizes.
WF: A few months ago, fund managers aggressively gave buy calls for duration funds, and now many are reducing duration in their funds. Is the bond bull market over?
Sivakumar: In our view, the bond market fundamentals are quite strong. While we remained somewhat lower on duration in the recent past, the current yields provide an attractive risk-return opportunity for long bond investors. We think that RBI is likely to remain accommodative, and once clarity emerges on the current concerns impacting the sentiment (especially fiscal policy), the markets will focus on the fundamentals. However as the last year demonstrated even rate cuts cannot lead to a secular bull market. There is the need to be active in portfolio management.
WF: What is your strategy in the duration space and how has it changed in the last 12 months?
Sivakumar: Over the last year, we have broadly been happy running a long duration bias (within the respective mandates) across our portfolios. However within the core strategy of being long, we have also been active in duration management taking profits appropriately. We believe that a dynamic or active strategy is key to navigate volatile market conditions.
WF: Spreads in corporate bonds between AAA and lower rated papers has widened considerably to around 200 bps. Is this a warning sign of impending credit risk issues or does this present an attractive investment opportunity?
Sivakumar: It is not appropriate to look at the credit space at an aggregate level since each bond needs to be evaluated looking at the specific risks impacting it. Having said that, we do believe that credit yields over the last 1-2 years have been driven less by fundamentals and more by demand-supply considerations. Further what is less appreciated in lower rated papers is the lack of secondary market liquidity in these papers. We remain extremely cautious on this space. Across all our funds we aim at maintaining high credit quality and liquidity.
WF: What is your strategy in the accrual space and how has it changed in the last 12 months?
Sivakumar: Accrual in debt papers cannot be looked at in isolation but only in conjunction with other risks such as liquidity, MTM and credit risk of the portfolio. We do not believe in getting unduly focused on the accrual number in the portfolio but rather focus on delivering superior risk adjusted returns across our basket of funds.
WF: Where do you see the best opportunities in the fixed income market now?
Sivakumar: Both short end and long end are looking attractive. However we believe that the best risk-return opportunity currently is offered by long bonds. Investors with low risk appetite should look to short term funds, while those who have a longer horizon while accepting higher short term volatility should look to dynamic or income funds.
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