‘Short-term debt funds may do well this year’

As the RBI infuses liquidity into markets, funds that invest in short-term bonds may outperform other categories.

The RBI has hiked the repo rate by 50 basis points in the last six months. Is there scope for further rate hikes?

The latest economic data and CPI (Consumer Price Index) inflation expectation over the next few months do not indicate any basis for a rate hike. On the contrary, they present a case for monetary easing by the central bank.

However, with the RBI formally adopting an inflation target and some macro uncertainties still on the horizon, we are not expecting a cut in policy rate either. We expect the RBI to focus on providing liquidity to the system. With limited reliance on OMOs (open market operations), the central bank may continue to infuse liquidity into the system through measures such as term repos.

Do you see further risks to the rupee?

The rupee has been stable in the last five months. A weaker rupee could extend the pause on rate moves by the RBI and, in the worst case, lead to rate hikes again. On the domestic front, an unexpected outcome of the general elections could be detrimental to the economy.

If the elected Government were to lift restrictions on gold imports, this could increase the trade deficit and the current account deficit in the next fiscal. With a weak monsoon being forecast, inflation could again be an area of concern.

On the global front, the Fed is expected to continue with its steady taper of asset purchases, which could possibly result in rate hikes in 2015 on the back of a resolute US economy.

This could lead to slowing down of arbitrage flows (by FIIs). Global risk aversion could gain ground if economic growth does not pick up in the US and Euro Zone and if China’s economy further slows down on the back of weak exports and growing concern on loan defaults.

Considering the past trend in 10-year G-sec yields, 9 per cent yield on gilts has proved to be a good entry point for investors. Do you agree?

Yes, in recent times, whenever the 10-year G-sec yield has hovered around 9 per cent the markets seem to have provided good entry points for investors. At around 9 per cent, the absolute yields are clearly at a five-year high.

Would you recommend corporate bonds or gilt funds at this point in time?

Based on our outlook for the near term, the short-term category may outperform over the next one year.

Accordingly, we have been advising investors over the last few months to increase allocation to the short-term category as we expect the RBI to infuse liquidity through measures that would lead to yields at the short end of the curve coming off and resulting in mild steepening of the yield curve.

However, for investors with no duration in their debt portfolio, it would be a good strategy to increase allocation to bond funds over the next few months.

UTI Dynamic Bond fund has performed well. What is the investment strategy? You have higher exposure to AA-rated NCDs; are you comfortable with the risk?

UTI Dynamic Bond Fund is an all-season fund that has the flexibility to counter a dynamic environment by actively managing the portfolio with the evolving interest rate scenario. It has the ability to mimic a cash fund when interest rates rise, thereby preserving capital; and generate attractive returns similar to that of an income fund when interest rates decline.

As far as risk goes, we have a robust investment process where each security goes through rigorous analysis. This is done under the guidance of the executive investment committee comprising Head of Fixed Income, Head – Dealing and Head – Research.

UTI Bond fund has not performed very well in the last one year. Why?

With 10-year G-sec yields increasing from 7.25 per cent in May 2013 to 9.25 per cent in September 2013 and stabilising at the current levels of 8.75 per cent, bond funds have been hit over the last 12 months. UTI Bond Fund is a long-term income fund with 45 to 65 per cent allocation to G-secs. So, while it reduced the duration in the rising interest rate environment, it is not akin to our Dynamic Bond Fund, and hence floored it at around six years.

So, its performance, compared with similar large-size, long-term income funds, has still been quite good.

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