5th March 2012

WF: At the outset, heartiest congratulations on winning the ICRA Award for the best debt fund house. What are some of the factors in your view that helped you come out on top in a competitive market place?

Amandeep: The award for the best debt fund house comes essentially by way of performance across all the debt funds within the fund house. What actually helped us was the fact that performance had been fairly consistent across our product categories. So it's not that we have sort of dominated or focused only on the performance of the liquid funds or short term income funds or only on duration funds. We have fund managers who are focused on a particular sub vertical. For instance, we have fund managers who look only after liquid funds, and then there are fund managers who look only after short term income funds or only after long term debt funds or hybrid funds and so on. So, I think this helped us to ensure that each fund manager had a very clear goal and target and was fundamentally focused on his portfolio of products in that particular category. So if we look at it, we have performed very well in duration funds, bonds and gilt funds where the outperformance is primarily a function of one's ability to predict or anticipate interest rate movements. The shape of the yield curve is important in short term income funds and there again we are one of the best performing fund houses. In the liquid category, again we have delivered a fairly consistent performance with a very high portfolio credit quality and our funds are well regarded by large institutional investors. So I believe that our ability to deliver performance across all product categories has helped us in getting the award. Secondly, looking at the overall cycles, we have been able to maintain a fair degree of consistency in both our return profile and relative performance.

WF: How do you see the 10 year G-Sec yields unfolding over the next six months and what are likely to be the key drivers of this segment of the market?

Amandeep: From our perspective, the macro picture clearly appears to be deteriorating which in turn is becoming a little rate positive. When I say macro situation is deteriorating; it essentially means that the economy is slowing down and typically it should trigger more focus on growth than just on plain inflation and liquidity management by the central bank. We had been tracking this from Apr-June 11 quarter itself, especially the aspect of corporate performance. Clearly, they are a good lead indicator of how the economy is growing and we have been continuously witnessing that Corporates have seen decceleration in terms of their demand. Overall industrial activity in the economy has been slowing down and that was a very compelling trigger and we made a very active call in the long term duration funds in the quarter ending June 2011. So frankly that has played out well and we also saw some rate hikes and a little bit of cautious stance on part of the central banks. We thought it was only the peaking of their policy actions. We still hold that view of economy slowing down.

Inflation which was sort of a centre piece for central bank and market in general seems to have moderated. At the same time we are not very sanguine on inflation as we don't feel it's going to come off or decline very sharply. We feel that inflation will continue to remain relatively elevated vis-Ã -vis what it have been used to. So we can look at inflation at around 6-6.5% but as I mentioned in the beginning, the central bank and the government in general is going to focus more on growth because sub 7% growth is not desirable for our economy. So I think that will essentially help central banks easing the rates. We have already seen a fairly prolonged pause. The next move from the central banks is going to be the rate cuts which are going to be attractive on the interest rates outlook. So from that perspective, yes, we would see the 10 year yields declining as a function of the extent to which the RBI eases.

While we have given a fairly optimistic outlook on the interest rates, I think the twin overhangs which are more technical in nature is the government's rising deficit against the supply of additional government securities which always tends to depress the 10 year yields every now and then. It is still going to remain an overhang on the economy. I think that's one key issue that one needs to be watchful for. Secondly, while we see inflation coming off from the 9% plus levels in the last calendar, it's going to be clearly closer to 6% now. It is not really that great but still much better than what we have seen.

So, clearly inflation at 6 odd percent and overnight rates at 8.5 is not desirable. It's a way too high. So we would expect the rates coming off by around 125 to 150 basis points over the coming fiscal and I believe that will drive the 10-year essentially to move in the lower trajectory. But if you ask me specifically for the next 6 months, the only uncertainty that we have to deal with today is the fact that one will find it very difficult to anticipate the central banks timing of these rate cuts. Looking at the rate cuts, the direction is clear and also the quantum is very clear from our view and we would expect at least 150 basis points cut. Consequently, the overnight rates would be between 7 to 7.5% from the current 8.5. So I think from that perspective, it offers a good enough positive real rate of interest with inflation at 6 in the coming year. But as we noted before, the timing is going to be a little uncertain because we don't expect RBI to be very aggressive on rate cuts. We expect them to be fairly gradual and conservative and if that materializes, we will clearly see about 75 and odd basis points cut in the first six months. So that's the view on the 10year.

WF: Do you see these RBI rate cuts impacting short term yields a lot more positively given that would be a little more sensitive to RBI's rate cuts than the 10 year?

Amandeep: Yes, that's right. In fact if you look at the current yield in both the sovereign as well as the corporate bond market, it's got a fairly sharp inversion especially now when we are seeing the short term rates continuing to spike almost every day. So going ahead, with any sort of firm indication from RBI or the first rate cut itself, you will start seeing the curve actually starting to peak which means that the short term rates will fall down faster than the long term. And that would essentially mean that short term rates are going to fall to an extent wherein the short term funds are going to become very attractive from purely an investment perspective over the next three to six months. So with the first move, we will actually see the curve steepening and once the conviction is built in the market and the easing policy is sustained, we will see the curve itself shifting down which is where the fall on effect on the bond and the gilt funds will come in through.

WF: You are saying that over the next three to four months, the better opportunities are in the short term income space whereas from a longer term perspective, probably the longer duration products hold considerable promise. But today for an investor who has one year plus money, what should an advisor tell him to do? Should he advise him to go in for duration products or the other end of the spectrum which is short term funds or would you say that he should recommend dynamic bond funds that can be a lot more agile?

Amandeep: The only issue with dynamic bond funds is the timing issue and there is a bit of a risk for the conservative investor because you could get the timing wrong and you may actually not increase the duration or you may actually move either well after the event or well ahead of the event and hence lose out on that bit. So a good strategy for a relatively conservative investor particularly in retail and to some extent HNI, would be to invest two thirds in short term income funds and one third in a bond fund and stay invested in it over the next one year. I think the composite structure is going to deliver a good weighted average return than staying invested in liquid funds or only in one year FMP's. So that's the strategy that I would recommend.

WF: In terms of the opportunities in the corporate bond space, do you see a lot of meaningful opportunities there or would you rather advise sticking to high graded paper but focus on the duration aspect?

Amandeep: Over the next twelve months, it will be good to focus on good credit quality and longer term paper yields because if you want to just trade in the fixed income markets, clearly the higher rated instruments are going to be more liquid which would provide you an easier exit when you want to capture that gain. And secondly, as I just mentioned we still have another quarter or two of poor corporate profitability and we are not going to see a significant improvement given the macro picture as there are concerns on commodity prices and the kind of margins we have seen. If you look at the aggregate level, Indian Corporates have not done so well in the December quarter and the March quarter is not going to be meaningfully different either. So our view on credit is that it makes sense to remain fairly conservative on credit quality. Once we see the bottoming out and start seeing analysts actually raising their expectations on profitability growth, it will be a good time to start looking down the credit curve. Then, clearly one will start seeing an improving financial performance going ahead and that will get reflected in credit migration.

WF: One of the issues that is worrying the industry is SEBI's new valuations guidelines especially in the ultra short term space. We have two issues : one is about the MTM rule for 60 days plus residual maturity - and from what we understand, SEBI has now given a breather until September. But there is also a diktat about fair valuation of all securities which is open to a lot of interpretation about what exactly is fair value and how can it be consistent across fund houses. How have you approached this whole issue and how do you see it impacting the liquid and ultra short term categories, where people do not like to see too much of volatility in returns?

Amandeep: I think the new guidelines on the valuations are more or less in line with the ones which SEBI had already indicated. Only issue is with the fair value or the methodology as that may create a little bit of an imbalance amongst the fund houses in the sense how they value. Your concept of fair value may be different from my concept of fair value. The earlier attempt from the SEBI in the eighth schedule and by AMFI itself was largely to standardize valuations so that everybody ends up valuing the same security in the same manner and there is consistency. So yes, there is some concern in terms of whether this difference in perception may sort of change or may have a different valuation being carried out but I hope that will also get sorted out very soon as I understand that AMFI is going to look at having a standardized valuation guidelines across the industry. So hopefully that will take care of that.

In terms of the MTM rules, the liquid funds have been given the time to adjust their portfolios. We will start seeing most of the liquid category funds further reducing their average maturity and the day to day volatility. But I think if you really look at the way Indian money markets behave, we just have to adjust to the fact that volatility is part of the game and one will have to accept volatility even in liquid funds. The band maybe lower because the fund themselves will keep using their average maturity to minimize the impact. Even if you look at say a year and a half ago, liquid funds used to give returns which used to barely vary in a 10 basis points band. Over the last one year, liquid funds have given returns which are very stable but the band has widened to almost 50 basis points. And now the band maybe further widened to say 100 basis points. I wouldn't worry about volatility translating into negative returns for a day - but volatility can certainly result in upto 100 bps differentials in annualized returns on a very short term basis between different liquid funds.

A second perspective is from the investor behavior point of view. We believe that people who come in with a typical one day perspective will not be able to really anticipate or measure the potential return as the range of returns will widen - so he could land up getting anything between say 8 and 9 % rather than expecting returns between say 8.5% and 8.7%. But, in this example, the investor who is coming in with let's say 14 days to 30 day period will essentially get say 9% door to door simply because the underlying portfolio yield in most of these instruments are held till maturity. So he will essentially realize that yield of the portfolio. And generally we have seen that investors who enter with a one day horizon in the liquid funds actually end up staying much longer than that.

Going ahead, we will see that these funds have reduced their average maturity then obviously the reference rate will also keep declining. So today you could buy a three month CD which would yield you almost 150 basis points spread from the overnight rates. If you start investing in just one month and two month papers over September then, that spread of 150 will be narrowed down to 75 or 100 basis points. So your portfolio across yield will also decline and that's something which I believe that our markets will have to adjust to.

WF: What in your opinion are the key risks to the Indian fixed income market that you would be watchful about over the next few months?

Amandeep: The risks essentially are more in terms of supply and that is what we are fearful of. In case we see a very sharp crowding out due to the central borrowings or alternately because of the prices in the global markets heading to a level where lot of those offshore borrowing turns onshore and that I think will essentially again push up the yields. We are in a market where you have limited savings and too much of it is taken by the government through its own borrowings. So you can just imagine if today the central borrowings are about 4.5 odd trillion rupees in a year, we have that much less available for the corporate and the private sector. And lot of the private sector funding is actually being met by going overseas. So if a part of that starts coming back and the government continues to stick to its 4.5 trillion rupees borrowing, it is clearly going to put a pressure on the domestic resources and consequently, it will push up the yields. That could make the markets again bearish and that is a concern.