Now, wait for the bull market in gilts

Radhika Merwin

Now is the time to invest in gilt and dynamic bond funds if you have a one-to-two-year horizon, says Maneesh Dangi, Co-Chief Investment Officer, Birla Sun Life Mutual Fund, in an exclusive chat with Business Line . Excerpts.

What does a stable new government mean to the bond market?

There are several important things happening in the market right now. First, there is a tectonic shift happening in the way India is being perceived by the rest of the world. The first reason is the expectation of a natural recovery — given that we have seen a considerable slowdown for three consecutive years. So, we would see some pick-up in growth. Second is that other comparable countries haven’t performed that well. While everyone is talking about the failures of the UPA Government, in the last one-and-a-half years it unleashed a slew of reforms, one key reform being the gradual deregulation of the fuel sector. The new government will benefit from some of these reforms. So, suddenly among emerging markets, India looks like a safe haven.

Also, a right-wing government (pro-capitalism), which the BJP or Modi Government represents, has the propensity to attract capital. Thus, the surge in capital flows can lead to $500-600 billion of reserves in three to four years’ time. It is important to remember that we have travelled a long way from our reserves dipping to around $270 billion and staring at a currency crisis back in August 2013.

This influx of big money will take care of the risk of currency depreciation. In fact, rupee may start experiencing appreciating bias. Even CPI inflation will be contained in the next one to two years. This will give enough headroom to the Reserve Bank of India to ease monetary policy which augurs well for the bond market.

What gives you the confidence that CPI inflation will be contained?

First of all there is a misconception in the market that the core CPI inflation remains sticky. Rather, our economy, which has been slowing down in the last three years, has been producing disinflationary impulses. In 2010, the industrial worker CPI inflation which was 13 per cent came down to 7 per cent. So, there has been a secular downtrend in the retail inflation for industrial workers.

So, our thesis is that given all the levers are in place — a tight monetary and fiscal policy, lower money supply and declining credit growth — inflation will come down.

The reasons for inflation can be monetary, fiscal or administrative. Right now the reason for inflation is administrative logjams and if a strong government at the Centre can resolve these issues, then inflation concerns will come down. If the supply side concerns are tackled efficiently, we can expect a more accommodative monetary policy going forward.

This will take time, maybe six to eight months, until the market can judge the ability of the new government. Remember, equity markets have the ability to price in the future a lot faster than the bond market.

For the next 12-18 months, what is your view on interest rates?

Our view is that rate hikes are behind us and we are in for a long pause now. While the next move is a rate cut, it is still some time away. The RBI will want to have a good handle on the CPI inflation before it starts to cut rates. In the run-up to March 2015, if the CPI inflation settles closer to 7 per cent, then markets will start to price in rate cuts. So rate cuts will happen only when the CPI inflation nears 7 per cent. Currently, the yield on the 10-year G-sec at 8.7 per cent is pricing a ‘no rate hike’ scenario.

What is the strategy you are adopting with your gilt fund portfolio?

We are fully invested in our gilt funds. We believe that the current scenario should pave the way for a bull market. The recovery, however, will be gradual. We expect CPI inflation to come down to 5-6 per cent in the next two years, which means that a bull market can be unleashed.

We believe that near 9-9.1 per cent is the peak for yields on 10-year G-Secs and there are huge gains to be made over the next one to two years.

Would you advise bond investors to invest in gilt funds?

Yes, investors with a longer time horizon can invest in gilt funds now. They can also consider dynamic bond funds, which provide a greater degree of freedom to the fund manager.

So overall, there are two strategies for bond investors. One, those who are looking at a one-to-two-year horizon can invest in gilt funds. The other trend catching up in India is the emergence of high-yield funds, which are available in different blends across maturities, with different risk profiles and yields. We believe that these funds can become larger than equity in the next two to three years because the opportunities in the fixed income space are immense.

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