This active duration manager explains his strategy

By Morningstar |  12-12-16 | 

Suyash Choudhary, Head - Fixed Income at IDFC Mutual Fund, shared his views at the fixed income panel discussion held at the Morningstar Investment Conference.

Despite the RBI cutting rates the benchmark didn't really move for a longest time and now we've had this sharp drop off in that. What are your thoughts?

The first part of monetary easing was purely rate cuts, not combined with emphatic changes in forward guidance and certainly not accompanied with liquidity changes in the market.

Early 2015 - the first phase till September-October, was almost purely rate cuts. The commentary was very two-way, very splattered with references to risks on inflation et cetera. So you never got the sense that they are very much behind this.

The dominant concern of the market was even with that 50 bps late September- early October 2015, the liquidity stance all the way till February 2016 remained exactly that - that so long as call rates are anchoring the repo rate, we are fine. It's after February 2016 when the RBI completely revamped its liquidity stance. Under the new dispensation, what looks like is the actual inflation band that they are kind of targeting is 4-6 instead of 2-6, which some quarters are viewing with a little bit of concern because in some sense we are today at peak disinflation.

So the argument is not really whether there is space to cut rates from a near-term standpoint. Of course, there is. The argument really is, for a country that has only recently started to win the inflation battle, should you use cyclical disinflation to build buffers around your targets or should you actually completely exhaust those cyclical buffers, which is really the question market it is debating with. But the near-term outlook looks quite okay for bonds barring global risks.

In terms of the growth, one of the engines obviously would be the transmission of the rates actually coming through to the economy. How do you see that playing out?

Bankers say that transmission is enough. I remember the SBI chairman saying that we have transmitted 95 bps of the entire rate cuts - which is not behind what you should expect given that when rates rise, bankers also absorb part of it. Money market obviously has been much more efficient as it should be, because once the liquidity leg is sorted, which is showing both in terms of the risk-free or sovereign rates going down as well as spread compressions.

So, if you look at spreads on various credit assets, they have narrowed quite substantially. That also is a part of transmission.

If you look at market access and the number of new entities that are now in the market, both onshore and raising offshore, that's also a part of the overall transmission process.

In the Dynamic Bond Fund you were at the long end of the curve. Earlier you cut duration and then corrected course. What was going on?

As a fund house we are active duration managers. Our Dynamic Bond Fund, income funds, gilt products are all actively managed. We get paid to manage certain risks – credit, duration, interest rate risk, liquidity, and make that work for investors.

So it never made sense to me to run, let's say, a government bond fund passively because I'm not going to haircut my management fees on that. Why should I not try and manage investment risk there as well? The downside is that we operate via frameworks. Sometimes, some assumptions on that framework change and we get behind that. So, in our case, it would reflect through our duration pack because we don't believe in hedging ourselves by saying that this fund is this and that fund is that. When we go out and market products, let's say, at the peak of where we think interest rates are about to turn, we don't distinguish and say, buy only my dynamic fund and not the income fund.

We are very proud of the way we managed 2013. At 5% current account deficit (CAD) we were reasonably sure that basically the one role interest rates need to have today is to get savings up - a 5% CAD is nothing but the excess of investments or consumption over saving. So we were around 50-60% in cash when that 200 bps interest rate shock happened. We did not restructure any portfolio after that. We just ran with what we were running before that.

The early part of 2016 wasn't pleasant. We believed that the RBI was very obstinate on their liquidity stance. I was not happy with the kind of supply or crowding out potential building up in the market. Adding the potential of government bond supply + Uday bond supply + state loan supply, I did not like the math. The principle is that after you have captured 100-150 bps, you are happy to let go off the last 25-40 bps. That’s why we turned into a 5 to 9 positioning. It did not work out then because the RBI completely flipped.

As what advisers and distributors need to watch out for is if our framework is consistent and our products are being run consistently within the framework, and whether 70%-odd of the calls are right. If that is the case, the 4-5 year performance is fine.

Going forward can you hold a low duration?

Recently, our favourite part of the curve is the 7 to 9 sector again, but we are tactically playing the longer end.

A very simple example: the new RBI dispensation is completely dovish. I won't say they have diluted the CPI framework because even under Raghuram Rajan that 4% in March 2018 was kind of a pipe dream. They weren't convinced of it but yet they would not doing anything to cause incremental disinflation via monetary policy. So, if you are not convinced it's going to be 4%, you will at least stop providing additional stimulus. So, a large part of it towards the end was stopped. But now it's kind of formal that it's not 4%, it's 4-6% that they're going to target combined with an easy money policy.

However, over the last number of days since the policy our bond yields have actually sold off. Because we are an emerging market. Globally, there seems to be some suspicion or nervousness with respect to whether at some juncture fiscal easing will get launched and G3 rates have responded to that or some event based triggers like the U.S. elections and responding to that, our bonds are also not moving.

We are alive to expanding duration, but in this last phase of the 50 bps on the table, I think risk becomes a little more two-way. Although, like I said before, with the 2-, 3-, or 4-month horizon, we remain quite constructive also because large open market operations will probably begin as soon as today.

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