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Indian market is not mature enough for credit funds

Puneet Pal, Head - Fixed Income, BNP Paribas MF

1st June 2016

In a nutshell

Indian investors by and large do not have the risk appetite ideally needed to invest in high yield funds and perhaps also do not comprehend inherent risks in credit strategies, says Puneet.

He believes duration strategies can give better risk adjusted returns to investors, and has established a performance track record that supports this view.

He does not agree with the widely held view that duration funds are only suitable for sophisticated investors. Well managed duration funds which focus not just on the upside but also on downside protection in volatile times, should be considered as an integral part of investor portfolios in his view.

WF: Your fixed income focus is weighted more towards duration strategies rather than credit strategies. What is the rationale for this?

Puneet: We try to generate Alpha through Duration strategies as compared to Credit strategies as we believe that the risk appetite of an average Investor in India is much lower with the requirement to protect capital at all times. We believe that currently the Indian Market is not mature enough for pure high yield Funds and not only the average Investor but sophisticated Investors also does not fully comprehend the inherent risk involved in pursuing credit strategies in the Indian Fixed income Space.

We believe that as the nominal yields in India are high and the real yields have also turned positive over the last 3 years, duration strategies can give a better risk adjusted return to the Investors.

Our strategy of lower credit risk has been vindicated over the last one year when Investors have suffered due to credit defaults / Downgrades in some of the high yield Funds.

We believe in generating superior risk adjusted returns over a longer period of time and our current strategy is well suited for this purpose.

WF: Duration strategies are popularly seen in our market as "make hay while the sun shines" - ie capitalize on falling interest rates, whereas your duration strategies endeavour equally to protect capital through bouts of market volatility. How have your strategies actually delivered on both these endeavours in recent years?

Puneet: We have been able to successfully navigate volatility over the last few years and have generated decent returns to the Investors. As one can analyse, the last 3-5 years have been pretty volatile for the Indian Markets with the yield on the 10yr benchmark bond moving in a volatile fashion from 7.25% to 9.00% and then back down to 7.50% currently (May '16; Source: Bloomberg). During this period of market volatility our income fund performed decently and also generates reasonable returns.

WF: In your experience, what are the key variables that materially influence duration strategies in the Indian context?

Puneet: In the Indian context, Fiscal Deficit and Inflation are the key variables which influence duration strategies. The new monetary Policy framework which explicitly targets CPI Inflation has not only enhanced the Inflation fighting credibility of RBI but has also put the onus on the government to sustainably lower the fiscal deficit in order to meet the Inflation targets.

WF: What is your call on the 10 yr G Sec yields - where do you see them at by March 17 and what are likely to be the key drivers?

Puneet: We expect the 10yr Bond yield to be around 7.00%-7.10% by March 2017, on back of higher Gsec Purchases (OMO's) by RBI and an incremental repo rate cut of 25bps. In the last Monetary Policy Review, RBI has stated its stance of reducing the liquidity deficit in the system from the current -1% of NDTL to neutral over the next 12-18 months and in order to infuse this liquidity , we believe it will need to do OMO's to the extent to INR 1.2-1.5 trn, which is expected to positively impact the demand / supply dynamics.

WF: How are your positioning your income funds in the present market context?

Puneet: We are maintaining an average Maturity of 11-12yrs in our Income Fund in line with our expectation of further downtick in yields over the course of next 6-9 months.

WF: Duration funds are widely regarded as suitable only for experienced investors with a reasonable risk appetite, and not suitable for retail investors. Would you agree with this positioning?

Puneet: We do not agree with this positioning as over the last 5-10yrs Income funds have generated returns to the tune of 8.50%-9.00% which is quite reasonable (Debt income category Source: valueresearchonline).

The fact of the matter is that investors should consider making Income funds an essential part of their portfolio in the overall allocation to Fixed Income. This is in line with the general conservative and risk adverse nature of the Indian Investor.

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