Current data on CPI inflation seems to be in a softening mode, rekindling hopes of rate easing, says Lakshmi Iyer, Chief Investment Officer (Debt) & Head Products, Kotak Mutual Fund, in a chat with BusinessLine . Excerpts:

Given the recent data on inflation, which has surprised positively, do you think the RBI will cut rate in the August policy?

The case for a rate easing remains high in the August Policy. More than the timing of rate easing, the key is to watch the incremental data points both on the domestic as well as global macro scenes.

Current data, especially CPI in India, seems to be in softening mode, which has rekindled hopes of rate easing. That, coupled with easy liquidity conditions, is likely to keep bond yields in fixed income soft in the near to medium term.

What will be the impact of GST on the MF industry?

For the MF industry, service tax rates will go up to 18 per cent from 15. We do not expect any material impact on MF investors on account of GST as the impact on expense ratios will not be substantial.

Recent credit rating downgrades hit many debt funds. What are the risk controls that you have put in place to avoid such credit risks?

Rating is not the only indicator of the health of the company. For instance, a company rated AA- could be a market leader in its segment, but may not enjoy the highest rating due to the industry in which it operates, for example, the NBFC segment.

Our first yardstick is to evaluate the underlying business, irrespective of the rating.

We are very selective about the credits that we invest in. Since the inception of Kotak AMC, we haven’t seen a credit default till date.

For credit of ‘A minus and below’, we approach our AMC board for approval as a prudent practice. In our credit funds (Income Opportunity Fund), we have one-third of the portfolio in one-year-and-below asset for liquidity management.

SEBI allows us to invest up to 12 cent in a single bond with Board approval, but internally we follow tighter norms.

You have doubled your investment in AA rated and below papers in the last one-year period...

In fact, in the last one year, portfolio quality has improved as the AUM size grew. I always believe you have to play the role of risk manager as risk is forgotten at the best times, while remembered by everyone in the worst times.

We like the non-AAA space and will be selective buyers in that space.

Do you think lower-rated papers are mispriced — not reflecting the risk?

If a company was a small-cap five years back, it could remain small-cap or go bankrupt or become a large-cap. When it becomes a large-cap, the value unlocking happens, and it gets a better valuation.

On the debt side, most of these companies initially were borrowing only from banks. As they are able to get access to cheaper funds in the market, they are able to do more business and therefore improve credit metrics. It is important to pick the company carefully not only in equity but also in debt.

So, is there more scope for play on accrual?

I clearly believe that the accrual category can more than double in the next 18-24 months.

Traditional modes of investment, such as bank FD, have seen reduction in rates in the past months, creating some demand for such strategies.

Which categories of funds do you recommend for retail investors?

At this juncture, out of ₹100, if you are allocating to fixed income, then allocate ₹80-85 to short-term funds or corporate bond-based accrual funds and ₹15-20 to actively managed long-term bond funds.

If interest rates fall, duration funds can provide some potential to enhance returns.

Otherwise, in any case, 90 per cent of your portfolio will offer stability with marginal exposure to duration.

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