Debt Funds Inside Out

ANUPAM: Hi listeners, we at Aditya Birla Sun life Mutual fund have come up with a special podcast series called MF 101 in collaboration with Bloomberg Quint. MF 101 is an informative series that will help you understand the recipe behind mutual fund investments and what’s more? It’s coming from the chefs of the mutual fund buffet table. From the very own fund managers and analysts who are the manufacturers of the funds that help you realize your investment goals.

Hi, I’m your host Anupam Gupta, B50 on twitter and in this episode; we are going to discover the recipe behind ‘Are Debt Funds For Me?’ from our guest chef Mr. Maneesh Dangi, Co-CIO, Debt at Aditya Birla Sun Life Mutual Fund. Maneesh, Welcome to the show!

ANUPAM : Maneesh, welcome to the show thank you so much for doing this for us. Lets start with this entire concept of a Debt Mutual fund because Indians have a long history of investing in physical assets likes real estate and gold; and lot of us are still used to fixed deposit but we know that debt mutual funds offer a completely new alternative to the fixed income side of investment. Let’s start with that what exactly are debt mutual funds? Who is it for? What kind of mindset should an investor have when he is looking for investing in a debt mutual fund?

MANEESH: So, fixed income funds or debt mutual funds as you say in terms of characteristics are somewhat similar to what fixed deposits would offer to investors, the Indian middle class and rich alike for them fixed deposits have been quite popular for a good couple of decades and a very larger percentage of their investments in fixed deposits is even today. Fixed income funds characteristics as I said is somewhat similar. These funds do tend invest in various securities of banks, NBFCs and lot of manufacturing companies and so on and so forth. Basically, we invest in these companies for fixed tenures say 3 months, 6months, 1 years, 2 years at a fixed interest rate. So, what we get in our portfolio is a certain rate in aggregate at a certain frequency and which finally we kind of deliver to our investors.

ANUPAM:Sure, there is this mind set that fixed income is for old timers. You know for people who are retirees and stuff like that. My guess is that the debt mutual fund or fixed income market today is vibrant. It has a lot of investment products across the board for a lot of investors. What’s your view on that?

MANEESH: You are right, you know that the output of fixed income fund is somewhat stable, and which is why one could say that state and therefore wait for hold. But for anyone who is looking for a fixed return to say or for a long period of time it is a right instrument for them. People who want to venture out, want to earn higher rich premia for them you know off-course there are other risk care asset classes to exist like equity and real estate.

ANUPAM:Great! So, let’s you know, if there were few very distinctive factors between debt and equity investment whether it is in mutual fund. Maybe you can just walk our listeners through that. What would be the distinguishing between these two? Maybe volatility for example?

MANEESH: You know before that I think the most important thing between debt and equity is the claim and the similarity. So, the similarity is that fixed income or debt also has the same claim on the balance sheet that equity has. It’s just that it’s ahead of equity. So, when I lend to a company and I invest in a company in equity the company whatever it earns first is it suppose to kind off pay back to the debt and then whatever is the residual goes to the equity investor as dividend. So, in a sense in terms of hierarchy of your claim it is ahead of equity and therefore it becomes fixed and also becomes lot more certain.

ANUPAM: Which is why dividends are paid only after you pay interest.

MANEESH: Absolutely! So, that also gives lot of stability to it because you know even if let’s say company prospects are dim today and it is not doing too well. As long as it has money to kind off pay back to the lenders of it, the leaders will get their money back but equity may not get it which is why the equity tends to be lot more volatile because it actually capturing the residual cash flow, after having paid the fixed income or the fixed lender so to say. So, therefore fixed income tends to be lot less volatile. Its in the end you know what you are getting in fixed income even when as fund manager or you as investor directly investing in fixed deposit of a company or a bank what you are getting is a fixed rate and that for a fixed term, if you stay invested in that instrument for 1 year or 2 year you going to get the same coupon. Let’s say you invest in some company for 9.5% or 10% for 2 years if you stay put in that instrument for 2 years you will get 9.5% or 10% unless off-course the credit risk materializes.

ANUPAM: Sure, which brings me to the next logical question the credit risk because the last year has been volatile. What exactly you know is your take on the current scenario the credit crisis and the instruments that are there, the loan that is shared, the volatility, where do things stand?

MANEESH: You are right, the overall last 1 or 1.5 years have been somewhat troubling for fixed income industry as such in the mutual fund space. Because lot of companies you know which were AAA earlier they were of good pedigree you know were promoted by good promoters so to say have actually been struggling for variety of reasons as such the macro economic environment for last two years has not been so great and lot of these companies had invested in business which actually didn’t do that well and hence the debt burden continued to grow up, eventually there came a point you know let’s say in case of IL&FS that because of tight liquidity they couldn’t get money from the market and effectively they kind of defaulted and that led to one after another companies going through stress lot of NBFCs began to see problems in terms of rolling over debt and therefore for last 7-8 months we had a full blown crisis so to say in the credit space. Having said that lot of these companies had actually build good physically assets and it’s likely that if overall macro-economic environment stabilizes and liquidity improves, most likely you know investors would not lose money in these assets even in the case of IL&FS let’s say because they are backed by hard assets and there is a reasonable value in it even after complete taking us out, there is value for equity investor and the promoters which is IL&FS in this case, you know most probably investors will get their money back and therefore at this stage its suffice to say that there was lot of volatility in the markets and some of these companies struggled but the prognosis for lot of these companies is not so bad.

ANUPAM:Great! You have mentioned about the macro-economic growth going forward and where we are, so I think this is also, the next logical question is where do we go from here? In the sense that the next few months will see few events on the political front, the GDP growth itself has been a little bit on the lower side interest rates I think the RBI has also shifted its stance and I know that the debt market looks at various indicators which are different from equity, right? It could be inflation, it could be IAP, it could be GDP growth, it could be interest rates. Where do we go from here now on all these factors?

MANEESH: So, on macros side you know basically you know what we beginning to see that at least globally that you know the growth across many develop countries is actually beginning to slow down. It all began in China, soon spread in Europe and now USA also is beginning to slow down and that’s the reason central bankers have stepped back and have actually turned a lot more dovish that what they were about a few months ago they were talking up the rates. Inflation surprising worldwide has been somewhat absent despite incessant growth that we had over a the last few years. The core inflation and general inflation has been missing so that is the global growth inflation outlook which is fairly biennial as far as rates are concern in India. Locally also we have had lot of policy induced volatility you had demonization in November 2016, then GST came in and even RBI’s policies have been very volatile, they were actually talking up rates just about a few months ago having realize that inflation has undershorts their expectation and growth also has moderated they have actually begun to talk down rates. They have cut repo-rates you know in the last policy. Broadly the environment right now is from a growth stand point is somewhat mixed. India’s consumption piece is actually beginning to slow down and while there are green-shoots as far as CAPEX is concerned, it’s very early at this stage and in this environment India, Indian corporates and Indian macro needs assistance from policy makers and which is what we are kind off beginning to witness. You are seeing as I said, rate easing and a general loosening of financial conditions from RBI. I think that would be continue for next couple of quarters and we would have relatively loose financial conditions. Frankly both debt and equity you know thrive in loose of financial conditions. Because you know in the broadly India’s growth outlook never deteriorated significantly, we are a vibrant economy and poor also therefore we are far away from frontier and we can easily grow at 6-7% and we can kind off pump a kind of loosening either in fiscal or monetary side we can touch a 8 % as well. So, given that the current macro is not that great and financial markets thrive on loosening that’s kind of coming their way it’s likely that the prognosis for growth for long term is very good while in the short run we might see some hickups coming in.

ANUPAM: Great! So, that you know if I am a debt mutual fund investor, I just heard what you said which is that we are looking at a loosening cycle. We are probably at maybe the worst of the crisis might be over might not be over, I don’t know. We have got you know in this kind of scenario, what should I as in investor do? How should I deal with so many moving paths going forward?

MANEESH: So, you know the good news is that fund managers are going to do these jobs for you. Our funds or other funds which kind of do a reasonable job in kind of insuring you get returns aligned with what you had expected, and your risk appetite is. So broadly in fixed income you have two sets of funds, one is treasury oriented and these are the funds which don’t take excessive interest & credit risk, your money is general safe in these instruments or these funds and they trend to deliver a reasonable 2-3% delta over inflation. In the end you must know the job of fixed income is to beat inflation. Good news is that you know about mutual funds, especially the treasury-oriented funds which don’t take credit risk and duration risk substantively. These funds do tend to earn about 2-3% real return verses inflation is concern. What kind of funds are these corporate bond funds, banking funds all sorts of short funds. Also you know for the investment horizon of less that 3 months or 6 months also we have funds like liquid funds, ultra-short term funds, money market funds so you must dial your advisor ask him if I have you know money which is to be invested where I am not looking for too much of a risk taking and I just want 2-3% excess return over inflation they will actually orient you towards treasury funds. In fixed income you also have growth-oriented funds. There the return profile is somewhat closer to equity in sense that it kind of starts to venture in some risk be it duration risk or credit risk. So, these funds are like dynamic bond funds, credit risk funds, medium term plan, so on and so forth. These funds you know earn about 2-2.5% extra return over treasury oriented fund by actually dipping into some bit of a credit risk in portfolio and these are the funds you know where you tend to have some accidents once in a while but over a long period of time you know these would actually give you better profile of returns. So, basically what you need to do now is to figure out what kind of returns you are looking at, if you are looking at just beating inflation by 2-3% and you want to mimic behavior of fixed deposit then you must venture into treasury oriented funds and if you are looking at some growth and extra return then you must venture into credit risk funds or dynamic bond funds.

ANUPAM:Ok, so the two takeaways that I can see clearly are the fact that one is that you need to speak to your financial advisor about any decision you are going to make, second is that you need to get your asset allocation right. You should be aware of what the risk and return that you’re willing to take. Am I right?

MANEESH: Absolutely!

ANUPAM: And on that positive note we wrap up this episode of MF 101. My guest was Maneesh Dangi, CO-CIO and he heads the fixed income team at Aditya Birla Sun Life Mutual Fund. Maneesh, thank you so much for joining us.

ANUPAM: Hope you enjoyed that! For more such interesting know how’s continue listening to our Podcast MF 101 or simply follow the blog page of Aditya Birla Sun Life Mutual Funds, Bloomberg quint, IVM podcast or wherever you get your podcasts from. If you had any queries or some specific subjects you want us to talk about, with regards to mutual fund investments, reach out to us on our Twitter handle @abcabslmf. Thank you for listening to this podcast!

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