The Hindu Business Line : Interest rates at medium/longer end likely to respond to global cues

Mr Santosh Kamath, CIO - Fixed Income, Franklin Templeton Investments, warns investors, even those who dabble in debt funds, not to take their decisions on the basis of short-term considerations. He also dwells on a range of issues - investors' expectations, debt fund returns and a rater's role in a capital-protected structure.

Excerpts.

What could make a difference to debt funds' performance in the days ahead?

Consider key factors like corporate spreads. We expect these to reduce from current levels due to increased demand and limited supply in the domestic markets, given the choice of borrowing through equity markets and abroad.

As for the long-end of the curve, the softness in global interest rates and oil prices could help yields come off in the 25-30 year segment.

In the short-end, while the rates could move up, investors could take advantage of the current steepness in the curve by investing at these levels. Policy rates in the short-term may continue to display an upward bias, influenced by liquidity and inflation considerations.

However, interest rates at the medium to longer end of the curve are likely to respond to global cues, with their implications for rate differentials.

In such a situation, how should investors react?

Under the circumstances, investors may benefit from an optimum mix between products such as short-term income funds and gilt funds. As always, our advice is not to base their investment decisions on short-term market conditions.

Any change in allocation should be based on overall financial needs, investment horizons and risk profiles.

As for the new fund, what could be the role of a rating here?

Well, Crisil's AAA (SO) rating indicates `a high degree of certainty regarding the timely repayment of principal' and the ability of this fund's portfolio structure to deliver capital protection. The rating provides investors the comfort of a third-party view on its ability to protect their investments.

"A cap protection product may not do so well when the market is advancing, but will deliver the goods when the market is declining." Do you agree?

This statement would be applicable for capital protection/guaranteed products that invest only in fixed-income securities. The capital safety fund we have launched would allocate a major proportion of its portfolio to high quality debt investments in such a way that this grows at a steady rate to make up the value of the original principal at maturity. The residual portion is invested in stocks, so that investors can benefit from the attractive return potential of equities over the fund's tenure. In that sense, rising equity markets will help the fund in delivering higher returns and protect the downside if the markets decline over the duration of the fund.

What if investors are concerned about short-term volatility in the equity market...

Well, this fund is ideal for those who have such worries. Its closed-end nature helps the equity fund manager to take a long-term view on their investments compared to a typical open-end equity fund. Also, we believe that equities have the potential to deliver attractive returns over a holding period of 3-5 years.

Besides, the downside risk associated with equities tends to reduce with longer holding periods and this is reinforced by back-testing for our diversified equity funds for the past 10 years.

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