Fasten your seatbelts, ladies and gentlemen
Shriram Ramanathan, Head – Fixed Income, L&T Asset Management
Bond market volatility lately has matched equity markets’ famed gyrations, causing many a sleepless night for the fixed income investor who yearns for peace and quiet. Shriram says its time to keep those seat belts firmly fastened and prepare for more through FY19, as oil, rupee, CAD and US treasuries exert pressure on bond yields. The very short end of the curve (3-6 months) as well as 1-2 yr corporate bonds are where he sees the best opportunities today.
WF: With the recent turbulence in the currency and inflation looking like inching up, is the case building up for an RBI rate hike?
Shriram: FY19 is likely to see wild swings in market expectations with regards to RBI action, given that we are at an inflexion point in terms of RBI monetary policy move, with the next move likely to be a rate hike. We believe that the RBI is likely to change their stance to a “withdrawal of accommodation” mode in June MPC and eventually start the rate hiking process in the second half of this year.
WF: Recent months have been unusually turbulent for the fixed income markets, with outlook changing very frequently. What’s causing this turbulence and how do you see the road ahead for markets over the next 12-18 months?
Shriram: Global repricing of developed market tightening and oil price volatility are likely to be continuing medium term headwinds for our domestic bond markets in FY19. Along with that, the markets recently had to deal with the various implications of the ongoing banking crisis, an upward movement in core CPI recently and a widening Current Account Deficit (CAD). As mentioned above that the FY19 is likely to see wild swings in market expectations about RBI action, both short term as well as long term interest rates are likely to remain volatile in the year ahead.
WF: How are you positioning your fixed income funds in this volatile market?
Shriram: While we were significantly underweight on duration position through most of last year, we had moved to a neutral position more recently in March when 10 year G-Sec yield hit 7.75% and short end rates too moved up sharply. Following the rally down to 7.30% in April, we have once again gone back to a significantly underweight duration position across various fund categories, subject to their fund specific mandates.
Having said that, apart from G-Sec market, we believe the upward move in interest rates in the very short end of the curve i.e., 3-6 months, as well as the 1-2 year corporate bond segment actually make it quite attractive for investors to benefit from the better carry that these segments earn. Our funds are accordingly positioned predominantly in these segments.
WF: Is there a case for investing in duration strategies now or should we stay clear of them?
Shriram: We expect G-Sec yields to remain volatile throughout FY19, and swing between 7.25-8.25% range, providing good tactical trading opportunities. Although, we do not believe the risk-reward is favorable for a strategic long duration position given various headwinds. If yields move to the upper end of this range i.e. 8.25%, investors who can withstand near term volatility and have higher risk appetite can potentially look at a longer duration strategy.
WF: Where do you see the best opportunities today in fixed income markets?
Shriram: While we are still cautious in our outlook for the longer end G-Sec market, we believe the upward movement in interest rates in the very short end of the curve i.e,. 3-6 months, as well as the 1-2 year corporate bond segment actually make it quite attractive for investors to benefit from the better carry that these segments earn.
Also - with yields in the short end of the curve having moved higher and with bank MCLRs expected to move up as well, we believe accrual funds which invest in good quality AAA and AA rated bonds in the 1-3 year segment can provide attractive carry for investors.
WF: What are the key risks you are watchful about now?
Shriram: While interest rate risk factors are being watched and tracked closely by everyone now (crude oil, US treasuries, CAD and INR), we believe investors also need to be careful about credit risks in the various accrual fund products they invest in.
At L&T MF, we follow a bottom up analysis approach giving lot of attention to the cash flow generation ability and debt serviceability on standalone basis. We firmly believe that a robust and process oriented credit risk approach of assigning internal credit rating to all the issuers, helps on 3 important fronts:
While we focus a lot of our attention on identifying upgrade candidates and adding performance alpha, we believe it is even more important to ensure that we are able to protect our investors by avoiding exposure to companies at risk of serious downgrades of more than 2 notches or slipping into BBB category.
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