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Where did we go wrong with debt funds?

Sujoy Das, Head of Fixed Income, Invesco MF

22 December 2017

In a nutshell

Sujoy Das of Invesco gives his insights into why the fixed income funds disappointed in 2017 and the prognosis for 2018.

  1. 2017: Change in monetary policy stance impacted bond yields

  2. 2017: Actual inflation versus projected inflation from RBI caught market unaware

  3. 2017: Impact from worries about fiscal slippage rattled the market

  4. For 2018: market has already substantially priced in negatives

  5. For 2018: Expects bond yields to trend lower after fiscal data is known in February


WF: Fixed income funds have disappointed in 2017, with 1 year returns ranging between 4% and 6.5% across all categories (other than liquid). What went wrong, what did we not see coming?

Sujoy: The first issue that really rattled the fixed income market early in 2017 was the change in RBI's stance from accommodative to neutral, on the back of RBI's worries on inflation - worries that were not shared by the market. That resulted in bond yields inching up initially. Then there were concerns around tax collection numbers and impact of GST concessions which started raising concerns on fiscal slippage.

Perhaps everybody in the market expected the inflation perception problem at first and then the fiscal slippage concerns later to be short term aberrations, rather than a trend change. That's what caught the market really off-guard.

WF: Where, in hindsight, should we have been more alert in spotting the trend change instead of hoping these would be short term aberrations?

Sujoy: There was a difference in opinion between the RBI's assessment of inflation versus what the market really saw on inflation. So in 2017, the average inflation has been closer to 3% but pretty early on, RBI governor changed the stance on monetary policy expecting fears of comeback of inflation but that didn't really materialise. Inflation infact went lower and lower till August. The difference in inflation forecasting by the RBI really caught the market unaware and the gaps in terms of forecasted inflation of RBI and the actual inflation resulted in the bond yields move the other way because the RBI changed the stance early on. This was what went wrong. Incorrectness in inflation forecasting resulting in a change in monetary policy stance caught the market off-guard.

WF: What is the prognosis for 2018?

Sujoy: On 2018, our sense is that the market has already priced in several negatives. It has priced in the slippage in fiscal, the higher oil prices, come back of some inflation and possibly also priced in a potential next rate hike. That's why the 10 yris closer to 7.25% today.

Bond yields moving up is a function of uncertainty around fiscal slippage. Until we have clarity on that, nervousness will remain in the bond market. Bond yields will start climbing down once there is certainty on the fiscal front.


If inflation stays where it is today - under 5% - we are not expecting RBI hiking rates in ahurry. But if inflation goes past 5% and oil prices also go past $70 a barrel and if it remains at those levels for a period of more than a quarter, then there could be reasons of hike in interest rate. But we feel since many of those fears are being priced in, in general, bond yield might trend lower once the fiscal data gets known.

The delay in communicating the fiscal stance may fan the nervousness and can take the 10 yr up to 7.50% levels, but once we have clarity on fiscal numbers, the 10 yr should drift back down to 80 bps above the repo rate - which is its normal level.

WF: Are there any major movements you are expecting in 2018 in any other parts of the yield curve?

Sujoy: Post demonetization, one never expected the liquidity situation within the banking system to turn so tight as it is right now. RBI has been continuously pulling out money through open market operations and MSS earlier. Hence the shorter end of the curve has also gone higher. Our sense is that at some point in time RBI may start infusing some liquidity through OMO, G-Sec sale as the liquidity situation is low. So the curve should get steeper than what it is today. The shorter end yields should come off from its present levels.

WF: How have your fixed income funds performed in CY2017? What steps did you take to minimize volatility in recent months?

Sujoy: Duration was used to reduce the volatility. We honestly did not expect at the beginning of 2017 that we would see a 100 bps spike in 10 yr yields during the year. We were expecting interest rates to follow inflation which was benign. That was the biggest disconnect we had in terms of the monetary policy. We did reduce duration at some stage over the year and reduced the duration overweight compared to the benchmark. We have brought it down to closer to where the benchmark durations are. Presently, we are looking to increase duration as we feel the real rates are just getting richer and a sustained higher inflation in the Indian economy is a lower possibility given there is hardly any pickup in the credit growth and overcapacity. While there is some food price inflation worries given the present price trend in few agricultural items and the increase in MSP hikes compared to last year, we feel it is not going to generalise into a broad-based overall inflation. We feel that there is merit in duration at this stage because several negatives are getting priced in and real rates are very attractive.

WF: How are SEBI's new fund classification rules impacting your fixed income funds?

Sujoy: We have a limited number of products and all the products have found a suitable categorization. There are several categories where we don't have a product right now. We are evaluating a few options and may want to selectively expand the product suite in 2018.

DISCLAIMER: The views are expressed by Mr. Sujoy Das, Head - Fixed Income at Invesco Asset Management (India) Private Limited. The views and opinions contained herein are for informational purposes only and should not be construed as an investment advice or recommendation to any party or solicitation to buy, sell or hold any security or to adopt any investment strategy. All figures and data included in this document are as on date and are subject to change without notice. The reference to the scheme(s) if any mentioned herein are only in context with the question asked and should not be construed as an investment advice or recommendation to any party or solicitation to buy, sell or hold any scheme(s) or to adopt any investment strategy. The views and opinions are rendered as of the date and may change without notice. The recipient should exercise due caution and/or seek appropriate professional advice before making any decision or entering into any financial obligation based on information, statement or opinion which is expressed herein. Invesco Mutual Fund/ Invesco Asset Management (India) Private Limited does not warrant the completeness or accuracy of the information disclosed in this section and disclaims all liabilities, losses and damages arising out of the use of this information.

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