R Sivakumar, Head - Fixed Income & Products, Axis Mutual Fund, believes that it is a good time for investors to invest in longer duration funds. Over the next six months, he expects yields on the 10-year G-Sec to fall below 8 per cent and anticipates one policy rate cut by the RBI within that timeframe.

What are your expectations on the rate front?

We believe that the RBI is over-cautious on inflation. In the latest policy document, while the RBI has stated that it is comfortable with retail inflation achieving the targeted 8 per cent by January 2015, it has indicated upside risks to achieving the targeted 6 per cent by January 2016. But if we look at the latest inflation figures, the headline CPI inflation is down to 6.46 per cent and the core CPI is down to 5.9 per cent.

So it’s no longer food inflation that is keeping inflation high; overall inflation is trending lower to 6 per cent levels.

So the 2016 target of 6 per cent is well within reach. What this means is that it opens up room for rate cuts over the next six months. Sometime early next year, we expect the RBI to cut rates.

The US raising rates some time next year may also impact the RBI’s decision on rate cuts…

The US Fed may hike rates in the middle of 2015 and for this reason, the RBI is mindful of the fact that it cannot cut rates aggressively. But also important to note is that a lot of things have happened over the last one year or so. For one, the fiscal deficit has come off sharply. This year (2014-15), the fiscal deficit will be at 4.1 per cent of GDP.

The new targets for the next two years are aggressive, at 3.5 and 3 per cent of GDP. This means that the fiscal deficit has to consolidate at a faster pace than earlier estimated. Two, the current account deficit has come down to 0-2 per cent of GDP. So the twin deficit problem is now under control. All of this should give the RBI comfort when they look at rate cuts.

Despite the key policy rate left unchanged for a while now, the yield on G-Sec has already started to trend lower…

In the G-Sec market, particularly on the longer end, the yields not only track the current repo rate, but also the future trajectory of this rate. So for instance, in January 2013, the RBI cut the repo rate from 8 per cent to 7.75 per cent, but this was done in the end of January.

However, by early January itself, the 10-year G-Sec yield was at 7.75 per cent. So the market starts to price in a rate cut beforehand. That is what is happening now and the market is moving toward a rate cut expectation.

So where do you think G-Sec yields will settle by the end of March?

Over the next six months, we expect yields to fall below 8 per cent and expect one rate cut by the RBI within that time frame.

So is it a good time to invest in gilt funds? What is the duration you are maintaining in your funds?

Yes, we believe it is a good time for investors to invest in longer duration funds. However, the risk appetite of the investor will decide the type of fund. Risk-averse investors can go for short-term funds, while risk-takers can invest in gilt or income funds. For Axis funds in particular, both our income and bond funds are running a higher duration of about seven years.

These two funds in particular have not performed very well when compared to other schemes. Why?

When we compare peers in this space, different funds follow different strategies. In the dynamic and income peer group, funds investing in money market instruments, short-term and long-term debt instruments — all get clubbed together. In the last three to four years, rates have broadly gone up. So we still haven’t seen a full rate cycle yet. Longer duration funds will tend to perform well in a rate cut cycle.

What kind of credit risk are you taking in your bond portfolio? How do you think the rating for corporate India will pan out?

In the very near term, we believe that the deterioration in credit performance has stopped. Credit quality is not getting any worse than last year. That said, we feel that the credit quality will not improve very significantly in the near term either. So we will continue to invest in better-rated debt papers for now.

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