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Move With The Wave
Dec 18, 2018
5 mins | Views 4871
Trees don’t grow to the sky, and few things go to zero, indicating that most of the phenomena around oneself, like the changing of the months or the seasons, recur regularly and thus are termed as cyclical in nature. Similarly the capital markets too can be thought of as following one such cyclic phenomenon. It is because of this cycle, when the interest rates are expected to go up, because the bond price movement is opposite to interest rates movement, the institutional investors generally prefer to invest in reducing maturity products. In such a scenario, the most popular reducing maturity products are the Direct Bonds which the investors hold till maturity. This is because investing in direct bonds help them minimise mark to market risks, and increase their visibility of income or accrual on a day to day basis. As the rate cycle reverses, these investors tend to come back to constant maturity products like Mutual Funds so as to benefit from the active fund management and duration gains. We see this transition playing out among investors, which makes us believe that the rate cycle reversal might be nearing. However, not many investors were able to take advantage of the first 80-90 bps of rate rally in G-sec as majority of them were sceptical towards the interest rates movement.
Key question therefore many investors ask is whether the rate cycle has decisively reversed.
Our CIO - Debt has been pointing out since 2016 that inflation targeting is one of the most far reaching policy indices that our policy makers have chosen. This eventually might even ensure that inflation becomes structurally low over the years and even decades in India. The impact of this? Well, as per his argument, the next peak in interest rate cycle will be around 8%, and not over 9% as observed in the peak of last 2 cycles, which has turned out to be so true!
The lead indicators suggest that after a sustained economic expansion for over 8 years, the US might slip into significant slowdown or recession by late 2019 or early 2020. Key indicators used here likely include slower fiscal spending, and spread between 2 years and 10 years US treasury yields getting inverted. China too has its own rebalancing challenges; anecdotally, every 4th house sold in China is the buyer’s 3rd house! If global growth slows down significantly, it can hardly be great news for India. After all, we have not decoupled completely, and are subject to the trade and flow movements.
So given the domestic inflation / rate outlook, and global growth dynamics, where might one put their money from here on?
While G-sec has rallied substantially over the last 3 weeks, corporate bonds have not moved meaningfully. For now, categories like Corporate Bond and Banking and PSU could provide a decent duration play with top-quality portfolio. It’s an ideal offering for Institutional investors, for the horizon of 12 month or more! Interestingly, majority of the time both of these categories have performed well over their net YTMs in the past. It is true that one should not keep the historical returns as the sole criteria for investments in any of the funds, however the historical returns do provide investors with some guidance as to in which direction one should proceed in. As one says history does not repeat itself, but it sure does rhyme.
Credit funds category is an interesting asset class that arguably has seen half the economic cycle in the grown-up size. It’s so heartening that Retail investors have got the spirit of the product right, and have not panicked in the recent bout of credit and liquidity environment. With a cushion above ~3% when compared to the AAA corporate bond category fund yields and a well-diversified portfolio, on the back drop of favourable rate environment, we believe Credit Fund and Medium Term categories could offer a reasonable return potential for Retail and HNI investors with a horizon of over 3 years. After all they offer over 300 bps p.a. spread over AAA, thick enough to absorb any credit shock and stay strong.
As in any decision making, in investing too, we as investors are subject to certain biases that lead us to suboptimal portfolio construction. One such bias is Home Country Bias. As we are all aware that there are a number of products or services we use on daily basis for which the profit gets accrued to companies in foreign destination. One can benefit from the business potential of these companies by allocating a part of their portfolio to global funds. For a well-diversified portfolio, one can do well to expand one’s portfolio to include Overseas Funds where the average category return over the last 10 years is ~ 11%.
Given the earnings track record of most companies over the last few years and a lot of optimism around macro policy making and leadership, one can argue that the markets generally have not been very attractively priced. However, there are certain bright opportunities for one’s equity allocation. One such idea that we find very timely is the Nifty Next 50 Index. Investing in one such fund might turn to be fruitful because of the following reasons:
- It’s an incubator for Nifty Index.
- It has a very strong Long-term relative track record v/s other large cap and mid cap / small cap indices.
- It offers with stability closer to that of large caps and a growth potential closer to that of large Midcap companies.
One scholar interestingly described risk as ‘more things can happen than will happen’. A lot of global and domestic macro along with political developments and events are likely and lined up in 2019. May you find a lot of opportunities and realise them.
Wish you and your dear ones a very happy and prosperous new year 2019.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
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