Morningstar’s analysts have assigned a ‘Silver’ rating to Birla Sun Life Medium Term Plan and Birla Sun Life Dynamic Bond Fund. Maneesh Dangi, co-CIO at the AMC discusses his strategy.
Historically, you've straddled both ends off the curve. In the Medium Term Fund, you've cut credit exposure a fair bit. I wanted your views on this space.
When to lend is my macro thesis. I am not in a business of always lending. The when is the macro call. End 2014 and 2015, the call is not to lend. So in a fund like Medium Term, I would build government bonds to the extent of 50%, much to the ire of investors who kind of seem, at least at that point in time, obsessed about higher carry and would continue to argue that why are you buying govies at 8.5% when a particular company is available at 10%. But at that point in time the macro wasn't conducive to underwrite credit. So I will not lend.
There were times when government bonds were available at 9% and many fund managers were lending to steel companies at 10%. I did not think there was a decent pay-off in this trade so I would rather lend to the government than to a steel company.
How to lend is a purely bottom-up exercise. Our focus is not to get obsessed about probability of default because even if I have a very good adverse selection mechanism, and I nurture my portfolios better, and underwrite better, I will get hit. A typical A-grade paper would also migrate 2-3% in 3-year rolling periods. I could neutralize it to a certain extent, bring it down to 1% or thereabouts, but I cannot neutralize it completely to nil.
Instead, I can focus on loss given default, or LGDs. If I have a good security or quarantine cash flows, then probably I would be up on the hierarchy and be paid out first. So I look for projects which have specific cash flows, or have some tangible and enforceable security specifically available to me.
That philosophy has kept us in a good state thus far. Let's say a company is defaulting and I have a facility which is unsecured and Rahul has lent secured, the world wisdom would be that he would default to both of us. But most probably he would be paid out and I won't. So, from a credit underwriting standpoint we are completely bottom-up, we look for specific assets or quarantine cash flows and always focus on LGD. Because there will be some probability of default in the market. For instance, some policies could undergo a change. Metal companies might go through huge pain if the commodity cycle turned malignant.
When you lend a little long-term, which is 3- and 5-years, you can't stipulate all of it while you underwrite a term sheet with the company. As long as you have a very specific and good security, I think you will be paid out and your LGDs would be minimal.
So, the math that I work with is that I'll try to bring down the PD, the probability of a default, in my portfolio to 20-30 bps points because my average portfolio of something like Medium Term is AA, AA+. And the real credit cost for me will not be more than 5- 10 bps through a cycle, essentially because I'll be able to recover most of it by selling the security.
In the Dynamic Bond Fund you run a sort of barbell strategy. You are buying 1- and 3-year corporates and really long-dated 20, 30-year G-Secs. What is your thought process?
Let's look at 2008. In the run-up to the rally, 90-95% of the fund was invested in government bonds. Then we thought the big move was over and we would get into a bit of bi-directional move in 2009 and 2010. Eventually, it got extended until 2013. But for 5 years we ran the portfolio as predominantly an accrual one with the duration of 2-3 years. Briefly in 2010, the duration was less than one.
Then came the 2013 shock. We thought it was a big cyclical as well as structural opportunity. We thought rates would come off by 2-4%, which is why we took duration to levels ahead 8-9 years. For a few years we have run that kind of duration. Of late, the rates have come down a lot and we still are bullish on the market. We still think that there is 40-50 bps more on the table. But balance of risk has now started to lean in favour of accrual. If I can underwrite a 3-year corporate bond at 8.5%, it's equivalent to 10-year bond rallying all the way to 60-70 levels in next 3 years. And it won't be able to outperform 8.5 of static carry.
The balance of risk is now starting to tilt in favor of accrual, but it's still not time to go outright low on duration. It's still not an appropriate time to be running low or ultra-low duration of 2010 and 2011.
So, we have kind of split the portfolio into two. One part would own the responsibility of carrying duration and predominantly, that's a 20-30 year part of the curve. I had to compress duration in my portfolio so that I am left with lot of part of my portfolio, which can be invested in high accrual so that my overall carry of the portfolio kind of builds up.
Dynamic is our unconstrained bond fund. We have spilt the portfolio: 50% is now invested in carry , which is what, let's say, Rahul (Bhuskute) would do in his portfolio, which is what I'll do in my portfolio of MTP. I have lifted the carry to levels of 8.5. Now, over next 6-8 months my job would be to reshuffle this part of the portfolio and augment carry in that portfolio. And the remaining 50% would continue to kind of run duration for me. So, the duration at this point in time is more like 5-6 years instead of 8-9, that I have run over last couple of years. And given that it's enticing to own reasonable assets now at 8.5- 9%, we've kind of split the strategy.
So, in a sense, that part of the curve, which is corporate 2-3 years, would induce a lot of stability in my portfolio. The rest of the portfolio would do the job of carrying the business of duration.
What are your thoughts on the more accommodative monetary policy stance going ahead?
We did this extensive study across the world wherever you had property prices dropping substantially or stagnating, in the end delivered a substantial amount of disinflation for years to come if not decades. This is how we started to build our thesis end 2013 and it stays intact. For 2½ - 3 years India is likely to witness a substantial amount of disinflation. The inflation of erstwhile years, 7-8% - would be a thing of the past.
Alongside is the large bust in commodity prices. Typical commodity cycles tend to last pretty long. And our base case is that you will have a good 7-8 years of low-ish commodity prices. That would mean low property prices or dis-inflating property prices and a commodity price bust. These are two important ingredients to deliver low inflation for years to come.
That's how things are likely to play out over the next couple of years.
Policymakers' response would depend on how growth is playing out. If we were to get weaker in the next couple of quarters, the response would be sharper in terms of a lot many rate cuts. And they have a lever of real policy rates. It could be as much as 200 bps in a buoyant growth environment. So at 4% inflation you could have a terminal repo rate of 6%. But if the growth is weak at 4% inflation, you can have a 5% or even lower.
Growth will be reasonable over the next few quarters is. It's not going to be as bombastic as 2003, 2007, or 2009-2010. But it's not going to be very weak as well. Which is why I think real policy rates would hover between 100-150 bps, which would secure you about 50 bps of rate cuts - give or take 10-15 bps. There are probabilities, but net-net, it's reasonable to assume that you will get to about 6% or 5.75% of repo in 3-6 months. And post that it would evolve based on how the growth dynamic is evolving.
The above is an excerpt from the fixed income panel discussion held at the Morningstar Investment Conference. Do read Maneesh Dangi's advice to investors and advisors.
