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WF: After the recent monetary policy review, many experts suggested that we should forget about rate cuts this fiscal. Do you share this view?
Sujoy Das: We believe that RBI is continuing on the right path in terms of trying to break the overall pressures on inflation and we feel that a rate cut at this point in time would be slightly premature. We do not know actually when the rate cuts would begin, but it should commence reasonably soon, once RBI gets comfort that the stickiness of inflation is over and inflation is going to stay low for a long period of time.
Inflation issue of India primarily is from two fronts - one is the fuel inflation and other is the food inflation. We believe fuel inflation will stay low for India, because currency stability is there and eventually US will become completely self-reliant, with its new sources of supply, thus easing the global demand-supply situation considerably.
On food inflation, both the RBI and the government are on the same page, and we can see a concerted effort to tackle this. Once the supply side constraints are broken, we feel that food inflation can remain benign for a reasonably long period of time.
WF: While there is a lot of enthusiasm about a turnaround in the economy, are you seeing evidence of pressure easing on corporate balance sheets? A year ago, many experts were wary of corporate credits. What has changed at the margin to make the market more confident now?
Sujoy Das: What has actually changed is the perception of risk. At the margin, there is improvement in the financials as well. Many corporates are able to borrow money at far more reasonable levels than what they were actually borrowing in the previous few quarters. In the last two months, we have also witnessed more credit upgrades as compared to downgrades. There are companies, which have also got upgraded into AAA status,which was unexpected even a year back. Even in our internal credit assessment model, we are witnessing more upgrades compared to downgrades and this is clearly positive and reflective of theimproving credit matrices. Things are loosening up. I think the corporate credit market is the first space where we are seeing early signs of green shoots.
WF: As more money comes into this category of corporate bond funds, questions are being raised about how deep the underlying corporate bond market really is and whether there are enough opportunities for incremental flows to get well invested. Is this concern valid?
Sujoy Das: Now if we look at the total market cap of Indian debt market, approximately 20 to 22% is the bond market. So 60% is sovereign, 22% is corporate bonds, and another 18% is money markets. Out of a total market cap of around $ 1.05 trillion (approx.), we are talking about USD 220 billion(approx.) of bond market - which is quite a substantial size. We also believe that as the economy recovers, there will be fresh issuances. Overall primary issuances of corporate bonds have also been growing over the previous few years, and it's not just happening in AAA space its happening in non AAA space as well. So I think the market is growing and becoming deeper. I,therefore, don't really have a concern about lack of investible opportunities in the corporate bonds market.
WF: What will be the mix of credits that you propose to include in this portfolio? How active will you be on going down the rating curve?
Sujoy Das: Our opinion about the credit market at this point is that the economy is showing early signs of strengthening, and we feel that both the government and RBI are on the right page in terms of breaking the vicious cycle of high and sticky inflation, which will help keep inflation low. On this basis, we see credit risk appetite increasing.
While the credit spreads of AAA over sovereign is pretty tight - (around 50 - 60 basis points), credit spreads of non AAAs over AAAs are still very attractive and close to their long-term average of 110 - 120 basis points. So in this portfolio we are looking at credits, which would primarily in our opinion are mispriced and/or move towards finer pricing over time.
As the economy opens up and issuers with A or AA rating at present will also get access to better source of funding, leading to credit spread contraction. That is an opportunity for us to tap today. In terms of portfolio mix, AAA could be just about 10% (approx.), other 90% we would actually be splitting between AA and A rated securities.
WF: What will be the duration that you propose to maintain in this fund? Can investors with a 3 year view hope to make capital gains in addition to healthy accruals?
Sujoy Das: Modified duration will be between 18-24 months. Given our view on contraction of credit spreads in A and AA securities, due to better capital access or upgrades,there can be some capital gains possibilities in the medium term. However, returns should primarily come through from the current high yield in the system, especially in A and AA rated securities. Investors should expect healthy accruals and should not build expectations of capital gains from such a product.
WF: Accrual based strategies are now seen as the best bet for 3 year+ debt allocations. Yet concerns surface from time to time about the illiquidity of underlying assets. How do you propose to manage this risk?
Sujoy Das: Yes, it's clearly something that one should address. Although 20-22% of the market cap is in corporate bonds, not all bonds get traded on a day to day basis. The turnover ratio of the corporate bond market is a fraction of the sovereign market.
As issuances increase, this can start improving. Moreover, with currency stability, we are likely to see increased overseas investors interest in this segment, which will also help improve liquidity. So, we believe that liquidity will gradually increase over the years.
Having said that, we will be keeping 10% of our portfolio in liquid AAA papers to manage liquidity on an ongoing basis. Moreover, we will be laddering the bond portfolio, which will also help in this regard.
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