Gilt funds would be a viable investment opportunity from a one year and beyond perspective

Kotak Mahindra Asset Management Company (KMAMC), a wholly owned subsidiary of Kotak Mahindra Bank, is the Asset Manager for Kotak Mahindra Mutual Fund. KMAMC started operations in December 1998 and has over 10 lakh investors in various schemes. Kotak Mahindra Mutual Fund manages average AUM of Rs 28636.86 crore as on June 2010. To know more about current scenario of Indian fixed income markets and investment options available to retail investors, Capital Market's D. Emerson Mcenley conducted an e-mail interview with Lakshmi Iyer - Head (Fixed Income and Products), Kotak AMC. Excerpts:

1) Give us an insight on the current scenario of fixed income markets in India? Share with us the views on G-Sec bonds and corporate bond spreads. How much percentage of your schemes portfolio has investment in corporate bonds?

The fixed income market in India is currently grappling with the transition in monetary policy from an accommodative mode to a normalized mode. In the process, benchmark interest rates are being increased. Consequently, the g-sec and corporate bond markets have been negatively impacted. Benchmark 10yr yields have risen to 7.85% levels. Also we have migrated from a liquidity surplus system to a deficient liquidity scenario which has lead to the shorter end of the yield curve spike up on an average 1.5%-2% over the last couple of months.

2) Which is the more lucrative investment option-short to medium term g-secs or corporate bonds, in current market scenario? Is it advisable to invest in long term government securities, in the wake of rising interest rates in the economy?

With 10yr benchmark g-sec yield approaching the 8% yield levels, it is our view that gilt funds would be a viable investment opportunity from a 1yr and beyond perspective.

3) What is your view on global bond market? What are the likely consequences of the forex-market trends for bond market yields?

Most of the global economies are still grappling with subdued growth which could inhibit them from raising rates in a hurry. This would be supportive for global bond yields which have been seen in the past few months. Even the US 10yr benchmark yield is currently trading at sub 3% levels.

As far as Indian markets are concerned the $ Rupee movements would be keenly watched. An orderly movement in forex market would be required for stable bond markets.

4) What's your take on the inflations numbers? How would inflation impact the debt market?

Inflation continues to be an area of concern as highlighted in the recent monetary policy review. There are concerns of inflation being more generalized in nature which could further aggravate the situation. Apart from significant evidence of demand-side pressures as seen in higher prices of non-food manufactured products, structural bottlenecks in commodities (pulses, milk, and vegetables) and de-regulation of petrol prices have resulted in higher inflation expectations. Also, the outlook on inflation would be guided by rainfall, commodity prices & domestic demand going forward.

The RBI has upward revised its guidance on inflation to 6% from 5.5% by the end of this financial year.

One of the ways to combat rising inflation is also to affect a hike in key benchmark rates which was one of the foremost reasons quoted by the RBI also for a mid meeting hike done last month. Hence rising inflation means rising interest rates, thereby negatively impacting debt markets.

5) What are the investment options available to retail investors, within the fixed income market, at this stage?

Rising interest rates should not be a reason for investors to shy away from the fixed income market. One must appreciate the fact in fixed income one does not lose his capital, unless there is a credit default as the higher yields tend to compensate for capital loss on account of lower prices. Fixed maturity plans offered by fund houses are a good way to benefit from the rising interest rate scenario.

6) What is your debt schemes' investment philosophy? As a fixed income fund manager what are your major concerns now?

The philosophy for us at Kotak Mutual involves around managing liquidity, duration, and credit across all our fixed income schemes. Investments are done taking into consideration the investment objective of the respective schemes and more importantly the time the investor would intend to stay invested in the particular scheme. For instance our Kotak Liquid fund would maintain a very low average maturity given that the investor would come in to this fund for even 1 day. Also on an ongoing basis the macro economic variables as also domestic events are monitored to fine tune the portfolios accordingly. To give a case in point, in today's environment liquidity is the key, hence most of our fixed income portfolio have shortened durations.

The major concern today as a fixed income manager is the movement in yields in a very short span of time. The effective overnight rate from 3.75% in April (reverse repos) has moved to 5.75% (repos rate) in under 3 month's time. Hence the market is still realigning itself to this eventuality - though the rise in yields is an opportunity from an investor perspective.

7) Kindly share your views on the recent credit policy review.

The recent policy has narrowed the liquidity adjustment facility (LAF) corridor from 150 bps to 125 bps by hiking reverse repos by 50 bps and reverse repos by 25 bps. It is very clear that the RBI desires lower volatility and has hence chosen to narrow the corridor. The concerns on inflation also have been highlighted with RBI of the view that inflation is now generalized in nature. The positive this is that the RBI will now do a policy review 8 times in a year which would also remove a lot of guess work that usually prevails between two meetings (since the review was done every quarter ).

8) How would you define your overall approach in managing interest rate and credit rate risks in an income fund?

We as a fund house have been pretty conservative on credit exposures and would not see that approach change very significantly in the near future. Interest rate views are actively managed depending on a host domestic as also global variables. At the current juncture, given that the yields have backed up quite a bit, we would favor adding duration to our portfolio.

9) What is your take on Rupee over near and medium term?

Near term $ Rupee is likely to remain volatile with a weakening bias due to higher than expected current account deficit. Also after the recent run up in Indian equities, there could be some apprehensions on valuations in the near term which could stall inflows. However, long term for the rupee continues to be positive as the fundamental outlook for India as an investment destination sees no change. Infact the RBI has also upward revised its GDP guidance to 8.5% for the current financial year.

Source: http://www.indiainfoline.com/Markets/News/Gilt-funds-would-be-a-viable-investment-opportunity-from-a-one-year-and-beyond-perspective/3216411660