Fixed Income Instruments in Falling Interest rate regime

Q: Hello everyone my name  is  Vipin Khandelwal and I welcome you to the very first episode of  our  Pod cast series,  in this Pod cast series,   we will demystify investing and help you become a smarter  investor.  Today we have been joined by MS Medha Budhia from Aditya Birla Sunlife Mutual Fund and she is going to talk to us about fixed income instruments. Welcome Medha. 

 A:Thanks Vipin  and like to be  kick starting our Pod cast series.

Q: Most certainly, let’s get started.

Q:  Medha our interest rates have been witnessing a downward trend for some time.   The central bank only has been holding back the rate cards but the future looks on certain.

A: Ya

Q : Although a smart saver  has been hit hard if you are a small saver or someone who uses traditional instruments to park your hard earned money you know how to feels,  it can be quite painful. In this Pod cast we're going to talk about this scenarios and the small saver, the investor who is confused about his or her investing options.

A: Sure

Q: Medha on the investor's behalf the 2 key question that I want  to cover with you today. 

1) What are the options available to the investor in such a scenario?

2)  How can an investor position the portfolio in social environment. Let me start with the basic one.

A:  Please tell me.

Q:  is there a possibility that we will see a drop in interest rates further or is this the end?  

A: NO so,  we are in midst of interest rate easing cycle,   believe that interest rates are due to ease further  from here.  Although we have seen a significant easing but there is still some lag remaining to this interest rate easing cycle.  .

Q: So is it like next three months six months  one year. What kind of a time period  I  as an investor keep in mind?

A: As of now we believe that in the next six to nine months interest rates, Repo rate  as we say is set to come down by another fifty bps at least.

Q:  OK so I mentioned the pain that I and many other small savers  face as investors.  What are the alternatives for us to the traditional saving instruments?

A: Vipin.  Traditionally small savers have only considered either fixed deposits or post office savings as    the available fixed income investment options.  If I were to see a little aggressive investors would have gone for Corporate  fixed deposits.  But investors must appreciate that with time and evolving capital markets, there are more investment options available.  So there are options so within the mutual funds space,  there are options like short term  funds like liquid funds, Ultra short term mutual funds and typically a short term traditional Investing investor (You know an investor who invests in traditional instruments) can go for these funds. These funds provide them with operational ease of investing and redeeming their money any time.  Moreover, for more than three years investment horizon, mutual funds are tax efficient as well.  More over a mutual fund mostly invests in a portfolio of instruments which are market linked.  Now they investing in market linked instruments, make them deliver market competitive rate of return as well.  And that is exactly why in falling interest rates  scenario   they just tend to help our Traditional small saving investors.

Q:  Great. I think you mentioned some of the benefits of investing.  Say mutual funds which invest in debt kind of investments.  One of them you mentioned is the ease of investing I mean and there's no penalty or exit Loads as we call in the mutual fund segment and I think one of the important points you brought about was or the taxation. Can you help us understand this more?  How is  more tax efficient?

A: Absolutely, so before thatNow Mutual funds are placed in such a way that basis an investor’s investment horizon there are a variety of products of available. And the exit load is aligned basis the investment horizon or the recommended investment horizon in that particular fund.  So typically our short term  funds are exit load free. While there are other accrual funds and dynamic bond funds they have a certain amount of exit load,  basis the investment horizon that we expect an  investor to be in the fund .

Q: Probably that makes sense too?

A: Yes. So if they are aligned to that kind of an investment horizon,  is what I mean.  Other than that you rightly mention that there is an operational ease of investing and redeeming from these products so if an investor were to want his money and  place a redemption today,  he's likely to get to his money  back  in T Plus one or T plus 2,   Today being the T day

Q:  T stands for transaction.

A:  Yes, the day you place the transaction. Other than that Mutual funds you rightly mentioned,  for more than three year investment horizon their tax efficient that being because for more than three years an investors can claim indexation benefits. While disclosing his  tax,   or while calculating his tax.

Q:  Is it similar to what happens when you sell a house or a  real estate property?

A: Yes . So here,  the calculation would be,   the tax rate is  twenty percent with indexation as the tax rate that is applicable.  which anyways compared to a traditional savings instrument,  traditional saving instrument if I’m not wrong is taxed anytime  at your personal  tax  slab?  So considering a highest tax slab would be still thirty percent and this would be twenty percent  plus the indexation benefit , so that makes the return more tax efficient 

Q: Absolutely. It is already looking like a wonderful investment option.  So let me take this discussion further and come back with a question that haunts the mind of a small investor.  The small investor is actually worried about the safety of the money, the big question on the mind is will I lose my money? Now with that  funds how safe  or unsafe he is or his investment is?

A: Vipin, while Mutual funds do not guarantee  returns, in written,  so I believe that a traditional savings instrument investor draws comfort from the fact that he gets it written in black and white on a piece of paper or where ever that this is the kind of  returns that he is going to earn. During the tenure  of his  investment, while mutual funds do not guarantee returns written in black and white. But  that is and that is because the mutual fund investment  in instruments which are market linked in nature.  What we have to appreciate is because of investing in instruments which are market linked in the  nature.   They have the potential to generate high returns as compared to the traditional savings instrument,  but at the same time while it may seem risky you know market linked return  may sound risky but we also have to understand that mutual funds are managed by professional money managers or fund managers as we know them.  Who have a lot of expertise in the area off money management, they have decades of experience doing this and only this.  Moreover they are also assisted by a very skilled team of   analyst who thoroughly  research on industries and sectors in which these funds seek to take exposure and basis their view and  analysis,   these fund managers decide to invest in a particular instrument belonging to a particular industry or sector or not.  All this put together  largely mitigates the risk of any investment going bad or doing a bad investment.

Q: Great, but there must be some internal guidelines also that prevent  fund managers or analysis to. seek out opportunities that may be risky or lead to a loss.

A: Absolutely so whatever I mentioned is apart from all those guidelines not just  internal  guidelines but also  our regulators guidelines so we are a completely  a regulated industry , we are regulated by SEBI Which has own set of guidelines quite stringent ones.  Then within the company as in every company internally has their own set of  guidelines,  apart from that there are these general measures which are taken to mitigate all sorts of risk before making an investment.

Q: So you mentioned about this market volatility thing. As I understand because there is a daily prizes associated with the investment portfolio now and in all of the prizes may tend to go up and down on a day to day basis, but with that investments up and down movement would be pretty limited.

A: Yes.

Q: It is not something that can really lead to a loss of capital if I'm understanding it right.

A: Yes, absolutely it is not likely to lead to a loss of capital and what must be appreciated here is that for any investment and debt mutual fund if, so we have typically recommended investment horizons for all kinds of different debt mutual funds if an investor were to be invested into a fund for the recommended investment horizon for which it to the suitable, there is actually very minimal probability of having a capital loss.  Historically mutual funds have proven that, over there about more than two decades of track record as well.

Q:  So I'll take a point from what you mentioned earlier in in our discussion, you said that there are so many types of debt funds short term, ultra short term, dynamic bond funds and honestly I can get confused and a small saver and small investor can get confused with these terms.  How do you make sense of them and what does a short term mean, ultra short mean, liquid mean, and dynamic bond fund mean?

A: OK so these are various categories of debt mutual funds that we have liquid in an ultra short term for a very short term parking needs  of say about of a week  or three months kind of parking need of an investor. Very comparable to very short term Traditional savings instrument.  These funds typically do not have any exit Load. And the instruments said that, the  debt instruments that they invest or of very short duration. So while as compared to these short  term fund would  ideally  be suitable for an investor for about six to twelve months  kind of an investment horizon,  again investing in good credit instruments like your certificates of deposit,  commercial paper or some bonds issued by corporates as well as government .  Dynamic bond funds like the name suggests is   very dynamic in  nature, these can invest in any combination of these instruments of any maturity, so it can invest in to a portfolio,   of only government bonds and corporate bonds of a little higher maturity or it can the times,  so if I could actually put it simply dynamic bond fund could become an Ultra short term fund at any time it would  could also become a short term fund or also could become an income fund.   

Q:  SO it can change its  colors basis on the  scenario.

A:  Yes.  it a fund a where you just need not worry about the market scenario what kind of product you have to look at, you just park your money there stay invested, leave it to the expert, the fund manager he is going to change colors change the character of the fund depending on the market  scenario.

Q: So if  I want to invest for a longish period of time and use only debt funds for my needs a dynamic fund is the answer.

A:  Absolutely so if historically as we have seen the way the fund has delivered it is a very consistent return generating proposition for a three  five year kind of an investment horizon. Q: Other point I'm understanding from what you've said is that  time horizon  is the  way to differentiated these funds.

A: Absolutely to invest into any debt fund you have  to answer to, two questions to yourself what the the time horizon for your investment horizon and what  is the quantum  of risk that  you would want to take?  so there are investors who do not want to see volatility at all in their returns,  for them there are certain kind of products which are suitable there are investors who ultimately want to see a certain range of returns that is expected out of. Not minding a bit of volatility in between but the end objective is what matters.  There are certain others, so there are funds for that also and there are investors who just want to park their money for very short term needs and you know they have certain time horizons or goals that they have in front of them.  There are funds for them also.

Q:  Great so coming to debt return funds  I'm still not able to grasp this concept power who should I think of returns from Debt fund,  is there are benchmark for reference that I can use?  I know you said that there's no guarantee that can be written down, but is there some way that I can gauge you know that this is the kind of return I can expect from Debt  fund investment.

A: debt fund is  only capable of giving you returns within a certain limit it is not like an equity fund, there is lot of upside, there is unlimited upside to it. But what one has to understand that again, like what I said some time back that these are market linked products and hence the returns that they generate. Are also linked to the kind of instruments in which these funds are invested. Debt funds mostly invest in or generate returns out of accrual or open payments which comes from instruments like  bonds issued by corporates, PSU’s,  government of various maturities.  All these instruments are   income generating and coupon bearing in nature,   interest bearing kind, so bonds like we have known   from our childhood time, our parents use to invest in the bond at a certain rate of interest that interest used to be paid out to us and every  quarter or 6 months a year.  Same thing happens here as well. It's just the same it is just that market has become, it's become a tradable market now where  bonds  get  traded.

But they still generate that   interest income and because by virtue of it, it is  getting traded there is a  possibility of making profit and loss which is over and above the interest income. This is a very simplistic understanding that can come.  So basis this there could be an expected range of return that every category of mutual fund is  likely to give.

Q: So  how should i measure of that?

A: So I'll just give you an example so if you were to look at a liquid fund it very simply invests in  certificates of  deposits in commercial papers of very very short maturity as short as three months it's likely So if they're running interest rates right now in the market, so the repo  rate in the market is  about six percent. It is likely to give you say twenty five or forty bps higher.

Q:  So Repo rate six percent  can expect to six point  two five percent.

A: within that within the very many one within that that does the broad range is what you can look at that's a very broad example.  Other than that of there are  funds accrual funds  which are suggested for a three year investment period there maybe you can invest say about one and half, two percent over and above for what your traditional saving the instrument rate is offering a very rough calculation.

Q: That's a good benchmark good thing that one can use.   Quickly we have been  talking about interest rates  what is  in store for the next couple of next year’s/ what kind of investment should we be doing in debt funds and what should be expecting from them.

A: If we were to look at an evergreen kind of scenario that accrual debt funds are steady income generating funds, like I just mentioned.  Because a large part of returns are generated from the  interest income which is generated by the bonds in the underlying portfolio.  The range in which they generate the returns vary on the basis of the market environment or the general  interest rate scenario which is there in the country.  These are basically your evergreen investment options under debt mutual funds which one can look at any point in time and   maybe with an investment horizon of about three years in the buff and they generate healthy returns for their investors.

Q: Great.

A: I hope I have been able to make you understand our debt mutual funds better during our conversation.

Q: Oh yes Medha. I think I have never heard such a wonderful conversation on debt funds, ever before. And I am enlightened, thank you for this.

A: My pleasure.

Q: And that brings us to the end of this Pod cast. Hope it was informative and interesting for our listeners you would be back again soon with a new expert and a new topic till then,Bye.

A: Thank you very much.

The views and opinions expressed are those of the Ms. Medha Budhia, and do not necessarily reflect the views of Aditya Birla Sun Life AMC Ltd /Aditya Birla Sun Life Mutual Fund

Aditya Birla Sun Life AMC Ltd (“ABSLAMC”) /Aditya Birla Sun Life Mutual Fund is not guaranteeing/offering/communicating any indicative yield on investments.Reference of traditional investments has been given for the purpose of the general information only. Investments in Mutual Funds Schemes carry high risk and should not be construed as promise, guarantee on or a forecast of any minimum returns

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