Rajeev Radhakrishnan, chief investment officer (CIO), fixed income at SBI Mutual Fund, has taken on the role of joint CIO at the fund house with R. Srinivasan on the equity side. The move follows the departure of Navneet Munot for HDFC Mutual Fund towards the end of last year. Radhakrishnan spoke to Mint on the lay of the land for debt funds, given the large government borrowing to support the economic recovery. Edited excerpts.
The inflation number in January at 4.06% was a positive surprise. What impact will inflation have on duration funds?
The moderation in headline CPI was expected, given that some of the supply disruptions, especially in vegetables and fruits, have largely normalized. At the same time, the inflation trajectory for CY21 and beyond is subject to a lot of uncertainties. Rising input costs including commodity prices, a recovering economic landscape, improved demand and stickiness in core inflation are factors that need to be watched.
In this changing macro backdrop, the prospects for long-duration funds would also depend on three factors—the government’s borrowing from the market, the RBI’s interest rate trajectory and its policy on liquidity.
First, let us take a look at the borrowing of the government, which is more than what has been expected by the market. The absorption capacity of the market is fairly stretched. This means the RBI will have to be more proactive with upfront intervention to ensure that this amount of market borrowing goes through. So far, the central bank has been more reactive, following an implicit yield curve control in the benchmark 10-year and intervening when the 10-year bond yield moves above 6%. That will not be sufficient for such a large government borrowing programme to go through. You may see a gradual reset of bond yields higher over the course of the year is likely. That in a way reduces the prospects for high-duration funds.
Second, let us turn to liquidity. This calendar year, you will see liquidity start to normalize in line with the momentum in economic activity. The amount of liquidity needed in a crisis era is vastly different from what is needed when the economy is normalizing. The RBI will be quite mindful of the fact that going forward, we will have to unwind liquidity and avoid any potential financial stability risks.
Third, let us look at the RBI’s interest rate policy. We may not see a reversal of rates any time soon, but it is certain that the RBI is done with rate cuts.
Liquid and short-duration funds have endured a year of very low returns. Will those returns go up?
Yes, we will see rates normalizing at the short end of the curve as the year progresses. At the end of last year, overnight rates went well below the reverse repo rate, going close to 3%. We had a situation where a large segment of the three-month and the money market curve was trading below the reverse repo rate. The RBI has given signals of bringing the overnight rate closer to reverse repo and we have already seen a rise in the shorter end yields. Going forward, the central bank will have to start active absorption of liquidity at some point. The first part of this process will be the unwinding of the cash reserve ratio (CRR) cut in April and May 2021, which will set the directional trend. Since categories like liquid and money market funds have lower maturity, repricing will be faster and investors in them will have higher carry.
How are roll-down products positioned?
Roll-down products very clearly have an appeal when we are at the peak of the interest rate cycle and interest rates are expected to trend lower like what we saw over the past two years. This enables roll-down products to be predictable in capturing mark-to-market gains from rate cuts. Going forward, we expect liquidity and interest rates to normalize. Hence, roll-down products will not be that attractive if you want to capture mark-to-market gains.
Having said that, we do not have this product category and we plan to launch two roll-down ETFs. One will be a 5-year roll-down fund investing in sovereign (central government) debt and second a 5-year roll-down ETF investing in state development loans (SDLs) and also in PSU debt. In the current context, investors in roll-down should be attuned towards locking in rates closer to the prevailing levels similar to what can be obtained through FMPs (fixed maturity plans). Liquidity is the additional benefit.
The economy is in recovery mode. Is now a good time to get into credit risk funds?
We have seen a shock in the economy that has impacted consumption and hence credit metrics at a broader level. Even though there are signs of recovery, there is uncertainty. There are issues like the SC moratorium on loan classification as non-performing assets. Of course, banks are reporting numbers that adjust for the moratorium. But we need time to get clarity to know the true nature of the covid impact and the extent of recovery. Even before the crisis, we had a deceleration of growth, which was quite pronounced in FY20. The overall outlook on credit should remain cautious and bottom-up focused. It is not advisable to position credit funds as the sole strategy in a debt fund allocation for all classes. These funds ideally should only be a part of debt allocation, subject to an individual investor’s risk tolerance and liquidity requirements.
What are your views on the RBI’s push for retail investment in government bonds and its effect on gilt funds?
The RBI’s move creates a potential new source of demand for government debt, which can be realized over a period. The push may popularize the concept of government bond funds (gilt funds), which have not gained enough traction among retail investors. These funds give you direct access to a credit risk-free asset class. Once awareness is built up, such funds will become more popular among retail investors. Gilt funds also have the benefit of active management and ongoing liquidity. Direct investment in government securities would give you a hold-to-maturity product. I do not think people will transact or book gains in direct investment.
However, it would have been better if some tax benefit had been provided for investing in government bonds directly to popularize this category and also to build a new demand source in the context of a massive borrowing programme that is clearly straining the market absorption capacity.