Navneet Munot, Executive Director and CIO, SBI Mutual Fund, shares his views during a panel discussion at the Morningstar Investment Conference held in Mumbai.
There have been talks that AMCs shouldn’t completely rely on ratings by agencies and must build their own research capabilities.
That’s critical. Like equity, credit is bottom-up. And one can't take a large macro call that credit funds or accrual funds have done well over a longer period.
For instance, REITs in the U.S. have been the best performing asset class, delivering 9% over the last 15 years. But within that, lots of people lost their pants during the sub-prime crisis. So if you take that broader call and put money in an asset class, you can get into trouble if you've not done the proper bottom-up research.
We've saw that in 2008 those who invested in income funds in the late 90s, early 2000 would remember such instances.
We did take a broad a macro call to stay away from global commodities, both in equities and bonds. But having said that, it's completely bottom-up.
Intensity of research matters - looking at the management, the individual company business model, and also governance.
In India, we don’t have a bankruptcy law. We cannot predict the probability of default or the loss given that default is highly unpredictable and very, very difficult.
Liquidity also creates a challenge. If there is a problem, you may not be able to sell that paper in the market. These aspects have to be built in when you are building your portfolio.
So in U.S., let's say there is a problem with British Petroleum and the bond trades at $85. Somebody might take a view that BP is going to survive being a 100-year old company. They may face some penalties but it’s not the end of the story for them. So they will buy at $85 and make money if the company survives. In India we don’t see that. It's either like Rs 100 or straight to zero. The liquidity aspect creates another dynamic, another challenge when you are looking at credit from a bottom-up perspective.
On top of that, running an open-ended fund creates its own set of challenges.
That's why I think the intensity of in-house research is far more important and critical than going by the rating.
You think liquidity will come to the debt market?
It will happen over time.
Raghuram Rajan in September 2013 had his own “Paul Volcker moment”.
(In 1978, in his first Federal Open Market Committee (FOMC) meeting as chairman of the Federal Reserve, Paul Volcker “defined his moment” saying: “Economic policy has a kind of crisis of credibility. As a result, dramatic action to combat inflation would not receive public support without more of a crisis atmosphere”.)
Modi in a pre-election speech stated that the government has no business to be in business, reminiscent of Ronald Reagan. Modi believes less government, more governance. That's India's Reagan 1980 moment.
EPFO taking on the risk of investing in equities as well as credit over a period of time, and SIPs almost reaching the 10 million mark. I think that's India's 401(k) moment.
And all these three things put together gave the U.S. a long period of non-inflationary, continued expansion where investors made money across asset classes. It also gave birth to several new markets – the junk bond market which did not exist between 1929 and 1977, when Bear Stearns and Mike Milken built the junk bond market; a large REIT market; a muni market which is $3-3.5 trillion; securitization and asset backed and mortgage backed securities.
Our journey from a $2 trillion economy to $6 or $8 or $10 trillion, cannot be complete given the kind of infrastructure we have in terms of the capital market. And innovation can happen given the strength that we have built in the whole ecosystem.
The episodes that we have seen in credit is very similar to incidents in the U.S. Be it in REITs, muni market, asset backed securities, mortgage backed securities - these events are very necessary for a healthy growth of the market.
I think this is just a beginning of the credit market in India. I think the necessary ingredients are falling in place.
The fixed income market is completely underpenetrated amongst the retail investors.
It will change over time.
We have already seen that tipping point where a lot of investors, due to lack of other avenues, are looking at fixed income funds differently. Last quarter around 2.5 lakh new folios got added despite all the media news around the credit funds.
The lack of other avenues is a strong factor. This whole change in taxation – everything taxed and maybe in another year or so we won't have too many of these tax free bonds. So the most tax efficient, convenient and probably efficient way of building your fixed income portfolio would be through the fixed income funds. Within that, there are a variety of products right from duration to credit to different kinds of hybrid funds exposing you to different segments of the fixed income market.
Why have you not been aggressive in building your credit portfolio?
I think credit is going to be a much bigger space.
Some of the events that we have seen in last few months will actually do a lot of good in the longer term ensuring that you get a proper risk adjusted returns. I think spreads have really come down to a level where we don't feel like really buying some of those papers, some of those bonds, some of those structures, because they are not compensating you enough for the risk that you are assuming.
People keep asking me why, if I am so bullish on the overall macro and India's prospects as well as the evolution of the credit market, I am not building upon it.
For the simple reason, I think they are not getting compensated for the risk that you are taking. If India is going to transition from this negative real rate to a positive real rate scenario, how are balance sheets going to get deleveraged? The people who are leveraged in last 7 or 8 years will have an even tougher time going forward, because asset values are going to grow much lower.
In the last seven years, if you look at the top 10-20 groups or companies, the leverage is actually increasing because good quality assets, cash flow generating assets have gone out of the books and the debt to EBITDA is I think mostly like six or seven and interest coverage is less than one. So you have to be extraordinarily conscious about really building your credit portfolio even with an improvement in the macro environment.
Building a credit portfolio is different than one person taking the duration call. We haven't really seen the credit losses, as in how do you really recover that money and how you go through that process. I think a lot of those things have to be in place.
