WF: Why do you believe that your Bond Short Term is an ideal product in the current market conditions?

Lakshmi: The philosophy of promoting Bond Short Term at this juncture is very clear, and that too more importantly when you are talking about a scenario where we all know that interest rates are headed upwards.

There are a set of investors who have medium term money (say a three to six month horizon) for investment, who prefer products of an accrual nature but are wary of rising interest rates. This money, which is parked in a liquid fund or a ultra short term fund, is earning them 4% to 4.5% -which pinches them as it neither beats inflation nor is an acceptable number on an absolute basis.

At the same time this investor class is very clear that given the kind of volatility they have seen last year, they clearly don't want exposure to aggressive interest rate risk wherein you invest in gilts or bonds of a longer duration.

So this gap is clearly being addressed by the short term category. Different fund houses have different strategies for their short term products. What we are trying to do is a slightly more aggressive ultra short term strategy - we try to generate a liquid plus sort of return over a six months horizon. How do we achieve this? What we plan to do and what we have been doing is that we are maintaining the duration at roughly around one year - which gives us healthy accruals and a limited mark to market exposure to help achieve the desired returns.

WF: What is the kind of return expectations that an investor can look at over the next 3 to 4 months from this fund?

Lakshmi: The ultra short term category funds are generating about 4% to 4.5%. In our bond short term strategy over a six horizon, it is fair to expect a 100 basis over the ultra short term category.

WF: Do you think that this investor class might get good opportunities around March 2010 to lock-in into a different set of products?

Lakshmi: If you are talking about lock-in products like FMPs, I think that the time you can start doing it now. Upto one year there is no point in thinking of FMPs because short term funds like ours should be able to achieve the objective. But for investors who are looking at one year and one year plus say between one to two years my sense is that from now on till March, FMPs should be attractive.

WF: What are the kind of yields you are getting on one year plus papers now?

Lakshmi: One year assets are available say between 6% to 6.25. If you go down the curve say18-24 months assets are available in the band of say 7% - 7.5%.

WF: Going back to the shorter end of the spectrum, there are some fears that now that RBI has made its stands very clear about mopping out excess liquidity, you might see interest rates hikes more at the shorter end rather than at the longer end. How realistic are those concerns and how will it impact your Bond Short Term product?

Lakshmi: Yes, rate hike concerns are very valid. And the short end is obviously most vulnerable. But the key question here is that the rate hike which we have been talking about probably can happen as early as the Jan policy - and the markets have started discounting it very much ahead of the time. And that is clearly evident in the shape of the yield curve right now which is fairly steep. To give you an illustration, today a 3 month asset is available at around 3% while a 6 month asset is available around 5%. A 1% difference over a three month gap clearly implies that markets are pricing in aggressive rate hikes in the near term. So, when we see the actual action of the rate hike, my sense is that the reaction will not be very dramatic.

WF: For investors who are looking at the Bond Short Term product, what are the things that you should watch out for that can perhaps spoil the party?

Lakshmi: I would say that given our kind of positioning wherein we are close to about 60- 40 in favour of accrual vis-a-vis MTM, downside risk is limited. What can go wrong? If rate hikes are well beyond what the market is pricing in, there could be a risk. If GDP growth is far in excess of market expectations, again, the tightening can be more aggressive than is currently envisaged.

Just a point on the 40% MTM exposure - this in my view is a misnomer because what happens is that as for the current regulations anything above 6 months is marked to market. For example I might be holding a 190 day asset or a 200 day asset in bond short term and that would still count as a mark to market exposure. The 40% number may optically sound very big or look very big, but if you go by the broader composition I would say that we are guided more by the duration of the fund which is under one year - which is comfortable. The other thing is that the portfolio is more skewed towards the corporate bonds over gilts and obviously corporate bonds are relatively less volatile than gilts.

Our focus is clearly on building up accruals in a rising interest rate environment which will cushion the potential of any negative impact of MTM exposure, if any.