Meet the Manager. ‘Overrated issuers may be the first ones to be downgraded’

With SEBI tightening the norms for rating agencies, any negative news may lead to downgrades, says Ritesh Nambiar, Senior Vice President-Fund Manager (Fixed Income), UTI Mutual Fund. Excerpts from a chat with BusinessLine :

What is your view on credit opportunities in the debt segment? Do you think the market is overheated, given the rally in lower rated bonds over the past one to two years?

The credit/income opportunities category has grown over ₹1 trillion and is one of the fastest growing segments in the debt category. Currently, credit theme is prevailing over duration due to uncertainty over further policy rate cuts amid rising inflation.

The category has seen good degree of upgrades and credit spread compression over the years. HFCs/NBFCs, which form a major part of the portfolio, have seen upgrade by multiple notches over the years.

The challenge from here on is the risk not getting adequately compensated amid ease in the availability of liquidity. Credit portfolio doesn’t have a high turnover ratio and hence most of the portfolio gains over and above the portfolio yield could remain unrealised. Moreover, credit rating migration will be limited as SEBI has tightened the norms for rating agencies. Any negative news on the sector or company may lead to downgrades.

Overrated issuers, where ratings are not justified, may be the first ones to be downgraded. This is not well-priced in the portfolio. Hence, MFs will be very selective as far as portfolio addition is concerned.

So, could gains be limited from the credit opportunities fund from here on?

The credit opportunities fund is an accrual fund. Hence, most of the portfolio gains will come from portfolio yield. Mark-to-market gains from here on could be limited. So, the way forward for such funds is to ensure addition towards right issuers.

That said, credit penetration within lower category issuers stands limited for mutual funds; hence MFs will continue to identify newer issuers/sectors.

The performance of your fund, UTI Income Opportunities, has fallen short of the category average, despite decent exposure (about 20-25 per cent) to lower-rated bonds. Why?

Currently, the category is vaguely defined. Short-term to medium-term credit funds fall within this category, i.e., duration of funds varies from 1.5 years to 4.5 years. As the interest rate cycle has been favourable, longer-duration credit funds have performed better than short-duration credit funds.

Hence, UTI Medium Term fund (medium-term credit product) will give higher returns than UTI Income Opportunities fund (short-term credit product).

UTI Income Opportunities fund has a good performance history in the short-term credit category, in terms of risk adjusted return — which means that for the underlying risk that we take, our returns are superior within the category of funds. For instance, the average exposure of this category of funds to ‘A’ rated bonds is about 30 per cent. UTI Income Opportunities has less than 10 per cent exposure to ‘A’ rated bonds.

Given the sluggish lending activity, banks have been lapping up bonds instead, over the past year or so. Has this impacted the dynamics of the bond market?

Yes, it has. Banks have been helping corporates reduce their cost of borrowing by tapping into wholesale markets. The excess liquidity that banks were left with, post demonetisation, further skewed the corporate bond spreads as bond demand far exceeded supply.

FPI flows into domestic bonds since March ’17 further supported the corporate bond spreads. Steady demand from mutual funds/insurance month after month also helped in reducing credit spreads across ratings.

What is your view on the interest rate front?

Globally, there is this issue that advanced countries are not able to re-inflate, keeping central banks tentative about their rate actions. In India, thanks to the sharp fall in food inflation, the overall trend in consumer inflation has been favourable.

But, just like the RBI, we believe that this could normalise and inflation head over 4 per cent by March ’18.

Hence, the room for further rate cuts could be limited. Thus, the fixed income market from here on is much more data-dependent.

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