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Saurabh says markets seem to be pricing in at least one rate hike from RBI – signifying a reversal from the decline and pause mode that we’ve seen in recent years. G-Sec yields can remain under pressure from April implying that duration strategies must continue to be seen as tactical rather than strategic allocations. Low duration high accrual assets is the place to be in the fixed income space, in Saurabh’s opinion. WF: Is the worst over now on G Sec yields? Do prices now factor in all the worries or do you see some more pain on bond yields in the coming months? How do you view the fiscal math in this Budget and what are likely implications on bond markets? Saurabh: Bond yields have benefitted from demonetisation as the slow growth cycle aided slower inflation amidst ample liquidity. With the process of remonetisation underway; growth and inflation have witnessed a rise from their recent lows whilst excess liquidity in the system has reduced. This implies benefits for bonds arising out of demonetisation have begun to ebb as reversal in growth cycle is often accompanied by a rise in inflation. The recent worries have been compounded with elevated commodity prices; especially crude oil prices. Teething troubles on GST implementation has led to uncertainty on tax revenues leading to flip – flops in government borrowing numbers. As things stand, government has pegged fiscal deficit for FY 2017 – 18 and FY 2018 – 19 at 3.5% and 3.3%, respectively. This is an upward shift from their earlier guided path for FY 2017 – 18 at 3.2% and FY 2018 – 19 at 3.0%. Bonds don’t like fiscal indiscipline and the same is reflected in rise in yields (fall in bond prices). A brief period (February - March) of no supply in government auctions can provide some respite to yields at current levels. As the government auctions resume in April; we expect G- Sec yields to remain under pressure. WF: Are duration strategies a good contrarian buy now for investors with adequate risk appetite and a 2 year horizon? Saurabh: The recent rise in long end bond yields indeed makes it enticing to use duration strategies to optimise returns. In times of an extended pause; duration strategies depend on demand – supply equation for long end bonds. Government borrowing programme bears a maturity profile of close to 14 years. Banks, the largest holders of government borrowings are expected to trim down their statutory holdings in government securities (SLR) as demand for credit has been picking up recently. With the SLR of the banking system being considerably higher than the statutory (mandatory) requirements, appetite for banks to absorb higher duration will remain low. Periods of bunched up supply would provide tactical opportunities in long tenor bonds and hence duration strategies would be deployed on a tactical basis and not as part of strategic allocation. Structural changes like increase in FPI limits in government securities increase in HTM limits for banks (highly unlikely) or open market operation by RBI will lead to reinitiating strategic allocations to duration strategy. Hence, barring a tactical allocation to duration strategy; strategic allocations to earn higher capital gains from long tenor bonds would not provide adequate risk reward in the near term. WF: How is DSP BlackRock positioning its duration strategies now? Saurabh: As mentioned above, we are underweight on duration and would use long tenor bonds purely as an opportunistic / tactical strategy. Extent of drop in CPI in latter half of this year; over and above other structural changes (increase in FPI limits, OMO purchase by RBI) which can induce appetite for duration assets will make us revisit our underweight strategy on duration. WF: With SEBI mandating that long term income funds cannot have duration of less than 7 years at any time, what are prospects for this product category? Saurabh: Long tenor bond funds will capitalise on dislocations in the long end of the yield curve as government auctions resume in April. As we are moving towards a rising interest rate regime; long term income funds would bear a higher allocation to tactical strategies and increased use of instruments like Interest Rate Futures and Overnight Index Swaps to hedge the duration strategies. Traditionally long tenor bond funds have cut down duration below 7 years in times of rising interest rate scenario. With the floor for duration at 7 years; the trading and market risk strategies of the fund manager would be the differentiator for this category of funds. With the availability of instruments to hedge market risks; this category of funds will reflect dynamism of the fund managers in the current phase of the interest rate cycle. WF: Does the rise in yields make FMP’s as attractive proposition for conservative investors? Saurabh: Bond yields have witnessed considerable volatility in the recent past. This has re-opened the avenue for fixed maturity plans which allows investors a chance to earn (predictable) returns without any exposure to volatility. Hence, FMP’s are an ideal recipe for investors seeking to remain immune from volatility. There is merit to cater to this demand from investors opting for nil volatility. Open ended schemes bearing short tenor bonds could provide favourable risk adjusted returns over the longer term (three years); albeit, bearing some amount of volatility and small phases of subpar performance in the interim. WF: Where do you see the best opportunities today in the fixed income space? Saurabh: Accrual, capital gains and trading are the three drivers for bond fund returns. With the reversal in rate scenario on the anvil; bond funds will have increased exposure to low duration high accrual assets. High sovereign rates have pushed the corporate bond yields close to / above bank lending rates resulting in demand for bank credit (loans). This has led to banks resorting to raise resources via certificate of deposits (maturing 3 – 12 months) implying pressure on the short end of the yield curve. With the repo rate at 6% and (one year) money market rates close to 7.50%; markets are pricing at least one rate hike at current levels. Highly rated (AAA) corporate bonds have been trading very close to lending rates of banks. Bank lending rates tend to provide a virtual cap on corporate bond yields as corporates can access bank credit reducing the supply of bonds at higher yields. Spreads between AAA and lower rated bonds have reduced providing an opportune time for investors to lock-in higher spreads without diluting their maturity and credit profile of their investments. Ultra Short Term Funds, Short Tenor Bond Funds and Dynamic funds - demonstrating ability to optimise accrual and duration strategies would remain the recommended opportunities in the fixed income space. WF: The current global sell-off in equities is being attributed to pain in the US bond markets, with some observers warning that there's more pain ahead in US bonds as the 30 year bull market finally ends. What's happening in the US bond market and what are likely implications on our debt and equity markets? Saurabh: In order to fast track growth; governments often embark on fiscal indiscipline by increased spending and reduced taxes. This indeed provides the desired growth momentum; which can spill over into inflation. Tight labour markets, higher growth and prospects of rise in inflation don’t augur well for bonds leading to rise in yields. Emerging markets can withstand narrowing yield differential with that of developed markets in times of strong macro stability. Recent pause in fiscal consolidation and prospects of rise in inflation would remain detrimental for narrowing yield differential between Indian and US treasury yields. Hence, rise in US yields will imply pressure on rising bond yields. Share this article |
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