Monday, November 21, 2011

‘Liquid funds are ideal vehicles for small investors'

It is ironical that retail investors own the riskier equity funds and not the least risky liquid funds.

This is not a good starting point for investors to bet aggressively on gilt funds. However, liquid funds, with their post-tax returns of 7-8 per cent, are an attractive option for retail investors, says Suresh Soni, one of the country's most seasoned debt managers and now CEO and Managing Director, Deutsche Asset Management India.

Fund managers have taken the call about interest rates peaking out many times in the last two years. But do you believe that we are now at the end of the interest rate increases?

I do think that interest rates have peaked out and the fact that the RBI has alluded to an end of the rate hike cycle is an encouraging sign. If you look at the government bond markets, government security yields have moved up recently on concerns over the government borrowing programme. However, if you look at some other segments of the bond market, rates have actually fallen in the last six months or so.

In the money market segment, one-year certificate of deposit (CD) yields of PSU banks were trading around 10.25 per cent in March 2011; they have, however, fallen to around 9.75 per cent by June-July and have stayed there since then. This has happened even as policy rates have been rising. Credit offtake has been slower and the aggression in deposit collections by banks has tapered off, leading to a stabilisation in 
Bank CD yields.

Can the double-digit returns made by ultra short- term funds in the last one year be sustained?
From the short-term rates perspective, we are at almost the highest level in the last decade. There have been very few instances over the last ten years when banks have offered close to double-digit returns on short term money. Therefore, I don't see these returns sustaining. Returns from liquid/ultra short term funds should decline, maybe from the second or third quarter of next year onwards.

Should investors begin to bet on long term gilt or income funds, if you take the view that interest rates have peaked out?
We will wait for sometime before taking an aggressive stance on gilt funds. While policy rates are close to peak, we think it will be sometime before rates start falling. Also, 10-year government bond yields at 8.8 per cent, at a time when overnight rates are close to 8.50-8.75 per cent, do not offer too much comfort.

There is a possibility of government borrowing overshooting targets. If divestments targets are not met, there could be further demand there. Since January 2010, ten-year gilt yields have risen by 150 basis points, but one-year bank CD yields have risen by around 450-500 basis points: all this against a policy rate hike of 400 basis points. The ten-year gilts have not responded fully to either short-term rates or policy rate hikes. Inflation too remains at higher levels. Therefore, as a fund house, we would avoid taking a very aggressive position in gilts. We would, however, be looking to take exposure in medium-term corporate bonds, with maturity of, say, two-five years through our income fund.

The ceiling for FIIs to invest in Indian debt markets has been increased further. What are the implications of this?
It makes sense to hike the FII debt ceiling. We have a rising deficit on our current account and we need foreign capital to fund it. If we are not getting equity money, then the alternative is to turn to debt, isn't it? Apart from this, we have the possibility of outflows of capital as FCCB redemptions for companies peak next fiscal. We would need capital inflows to compensate the shortfall.

Therefore, opening up fixed income markets for FIIs will be a good development. However, the bulk of inflows from FIIs so far has been in the one-year segment. An interesting move here would be the raising of ceiling for FII investments in government securities, as FIIs may be keen to buy gilts. India's interest rate differentials with other markets are quite attractive.

Will the savings bank account deregulation, impact liquid fund inflows?
I think the impact of the deregulation has been very limited so far. Even after the hike on saving bank rates, the liquid funds are delivering significantly higher returns.

If you look at liquid funds, their penetration level has been very low. Only 3-5 per cent of the about 40 million folios in the mutual fund industry are with liquid funds. I believe there is a large section of the population to whom liquid funds have not been marketed at all. Finally, the major chunks of liquid fund investments are from corporates and high net worth individuals. For this segment, liquid funds are more tax efficient than bank deposits.

I think the potential to acquire new investors in liquid funds is very large. Many individual investors are not even aware about liquid funds. They are not aggressively marketed by distributors as well. I think liquid funds are the easiest vehicles to own for small investors. Today, retail investors can make close to 7- 8 per cent post tax on liquid funds, with ‘ anytime liquidity'. It is ironical that retail investors own the riskier equity funds, while liquid funds, the least risky category, are owned by companies and high net worth individuals.

Source: http://www.thehindubusinessline.com/features/investment-world/mutual-funds/article2642506.ece

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