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WF: Investors are often counseled not to chase funds only on the basis of recent performance. There seems to be quite a momentum building on MIPs in recent months - and co-incidentally, just at a time when recent performance has looked up. For investors who come in now, can you please articulate what is the investment argument for MIPs going forward? Is there reason for any fear that investors may be jumping onto a bandwagon after most of the returns are already in?
Lakshmi Iyer: Investors do have the tendency to chase returns in the near term - and this is true in all types of funds including MIPs. There have been positive net sales after quite some time in the recent few months. Nevertheless your observation is absolutely bang on.
MIPs invest in debt predominantly and some in equity.The outlook for debt is definitely positive because we are in a scenario where the interest rate cuts after a long gap have begun and though it is going to be gradual in nature we definitely expect moderation in interest rates which will auger wellfor debt as an asset class for a good part of calendar year 2013.
If interest rates are getting cut, it is a positive for equities. But there has been a significant run up in equities in calendar year 2012, we may see extended period of consolidation/sideways movement for 2013 and it would be a predominantly a stock pickers market.
I have only two suggestions to make to investors -
Do not get guided or carried away by the past one year kind of a euphoric performance where we saw both debt and equities perform phenomenally well. There were high double digit returns for both.
Moderating expectations and allocation with a slightly long term outlook will be rewarding in today's market scenario.
In today's market scenario getting high returns from MIPs is not going to be a cake walk because bulk of the returns that accrued last year actually happened on the back of a robust equity market. The broad indices were 25% positive and the mid cap index was close to about 35% to 40% positive and stocks have mirrored that kind of returns. The beginning of the calendar year 2013 has not begun ona great note from the equity stand point which is obviously reflecting in the near-term year to date calendar year in the performance of MIPs as well. So it is not going to be an easy cake walk for the fund manager to deliver reasonably high returns. But there will be anendeavour through active allocation between equities and fixed income to be able to come closer to them.
WF: Your MIP has done well - and has been significantly and consistently ahead of category averages. What are some of the strategies that have worked for you in delivering this performance in your fund?
Lakshmi Iyer: We will look at fixed income first. In the fixed income part of the portfolio, we adopted a dual strategy. We focused on accrual for a good period of time and once the clarity on interest rate emerged more decisively we started increasing the duration on the portfolio.Our duration was between a bond fund and a bond short term fund running on the duration in the band of 3 to 4 years.
On the equity front, the strategy was clearly being overweight in the mid cap segment because we had a fairly constructive view on the mid cap segment for the good part of 2012 and that reflected in the portfolio construction as well. About 50% of the portfolio was in the mid cap stocks of the equity component. The idea in the equities portion was not to have a very long term view and not really churn the portfolio aggressively. We were somewhere at the midpoint wherein we tried to target absolute returns from stocks and once that stock delivered in line with our expectations, we exited the stock.There was an active dialogue between equity and fixed income which in combination has achieved this kind of performance.
WF: What is your outlook on debt markets for the rest of 2013 and how are you positioning the debt component of your MIP in this context? In terms of the overall debt market outlook, how do you compare this market with the last big bonds bull market that we saw in the 2000-2003 period?
Lakshmi Iyer: Our outlook for debt markets for calendar year 2013 continues to remain fairly positive due to growth and the inflation numbers. Both WPI and the core inflation which the RBI tracks pretty keenly are on the decline. We saw the recent WPI numbers also come as a positive surprise for the bond markets as far as the core numbers are concerned. The next reading is also likely to be positiveand is supportive of the view that we have scope for reduction in the benchmark rates from here on.
We believe that at the end of year 2013, the repo rate maybe in the band of 7% to 7.25% which is currently at 7.75%. Not much of it is discounted in the current yield curve which means that there is scope for further easing in the yield curve in the months ahead. This of course translates into positive returnsfrom the fixed income stand point. We also believe that a good portion of these returns could be front loaded in calendar year 2013 which would reflect in our MIP positioning also where we would initially try to run a longer duration and try to capture some positive returns and gradually shift focus to an accrual based strategy within the fixed income space. We need to jugglein 2013 to ensure that we do justice to the money that we get.
If we are to draw parallels to 200-2003,one fundamental difference is that 2000-2003 was a period characterized by extreme low growth but we were on the onslaught of a credit cycle so the SLRs that the banking system was running was in excess of what it is at this point in time. This is not the position today. If 2000-2003 was a period of a secular downward decline in interest rates, this period is not a secular downward movement in interest rates. The trajectory of interest rates is clearly headed lower,the ranges will keep shifting downward so you are going to see a tight range in interest range movements because there is a clear effort to streamline the growth rate back to upwards 6.5% to 7% over the next two years. There would be many more takers in the credit spectrum. That is the fundamental difference which is reflected in the returns.
About ten years back gilt funds and bond funds gave returns similar to what some of the equity funds have given in 2012. We are not really expecting a repeat of that period in 2013.
WF: It is a correct observation that debt and equity markets do not perform well at the same time? Most experts expect healthy returns this year from both debt and equity markets. How reasonable is this expectation, from a historical context?
Lakshmi Iyer: It is a dichotomy, from a historical context. From a fundamental point of view, while lowering of interest rates is directly positive for bond markets, the expectation of a rebound in the economy because of the cut in interest rates also tends to be a positive for equities. To that extent it is fair that both the fund managers have a reasonably optimistic outlook.
If you see the empirical instances taking the last 3- 5 years, there have been very few instances where you have seen a debt and equity market in terms of returns co-exist. In 2012 both the asset classes gave very healthy returns - obviously equity market gave higher returns but both were in double digits in terms of returns.Apart from that I cannot recall any instance where we have actually seen both the markets perform well in the same year.
But in 2013, returns in fixed income could be front loaded and because of the expectations of cut in interest rates and if you look in the current yield curve you could see theinitial period of 2013 being an exuberant one for fixed income and probably could taper off in the second half which could give investors still reasonably good returns from a fixed income perspective.
Equity markets have run up sharply last year and with everyone in the Street being positive on the Budget, we may find it difficult in the near term to look for drivers to keep moving the equity market higher - at least in the short term. So there could be a period of consolidation in the near term through range bound markets. The markets have displayed a volatile mood and hopefully have to see some more action going into the year and the second part of the year could hold more promise.
So in that sense we probably could see convergence of returns.Obviously one market gives way which in our case we believe that probably with the onset of better growth expectations, interest rates stabling after cuts one could probably start moderating returns from fixed income into 2014 mid onwards.
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