Smart Talk with Nagarajan Murthy


Nagarajan Murthy is the Head of Fixed Income at Tata Asset Management. With an expertise spanning decades in the debt market, Murthy brings in a rich and valuable industry experience of more than 21 years in the financial services space.

In this interview with Geojit Insights, Nagarajan Murthy talks about Fixed income market, the challenges and prospects.

What challenges debt fund managers are facing in the current market situation?

In the current market situation, debt fund managers are facing two main challenges. First challenge is on managing investor expectations especially after one of the longest secular bull phases of fixed income is coming to an end. Since January 2015, RBI has reduced policy rate by 200bps and at current juncture likelihood of rates going up is more. Investors who had entered during last 3 years have earned good returns on their fixed income investments but outlook for next three years is not as good as it was for the last three.

And second challenge has more to do with evolving macro-environment where liquidity in the markets across asset classes is drying up (with fixed income being no exception) and volatility is increasing due to both domestic and global factors.

What is you forecast on rate trajectory looking at the US market events and domestic developments?

One major take-away of February RBI monetary policy was that although RBI took cognizance of upside risks to inflation emanating from fiscal slippage, crude prices and MSP hikes in budget, it would like to see how these risks materialize going into H2-FY2019 as it expects inflation to come down to 4.5% levels in second half of FY2019, which is closer to its medium term target of 4%. This basically implies that risks on inflation need to unfold in meaningful manner in FY2019 for RBI to first change the stance and then embark upon rate hiking cycle. RBI’s press commentary suggested that RBI would like to be in wait and watch mode for foreseeable future and rate hikes have been pushed further away.

Incremental data, post February policy has been positive for fixed income market. CPI is tracking 50bps below RBI’s Q4-2018 average and growth indicators (GDP and IIP) have come in line with RBI’s expectations (although stronger than market consensus). In this back-drop, we believe that policy rates will be in a phase of prolonged pause going forward, this may present opportunity in the short-end of the curve (steepening bias) as short term rates had also hardened significantly and with no immediate danger of rate hikes, this might present a good risk return trade-off. We expect 10-year G-sec benchmark to trade between 7.40%-7.80%.

Do you foresee a fresh appetite for duration schemes to emerge in near future after the rate tightening saga ends? If so when do you expect that to trigger?

We think investors are timing the entry into fixed income assets. Currently 10-year GSec benchmark yield is trading at a spread of 160bps above over-night rate. The primary reason for such high spread is lack of real demand from PSU banks. At these spreads, GSec yield curve can withstand 50-75bps of rate hikes going forward (provided, demand supply situation turns neutral, from extremely unfavourable currently).

While the macro-outlook for bonds is constructive, investors are looking for the following signals for a better entry point – possibility of a spike in yields in April when fresh supply of bonds hits the market, signs of buying from the public sector banks, the details of the H1-FY19 borrowing calendar to be announced later this month which could spread supply pressure evenly across the curve, opening up of FPI limits and some depreciation in INR. Investors remain sanguine about the medium term bond demand-supply dynamics although RBI Open Market Operations (OMO) expectations are back ended.

What good and bad do you see in the way RBI as well as the government respond to unfavourable market events? Is there any better way to deal with the situation?

We feel that one of the reason for such a sharp rise in yields from September 2017 onwards was because of the uncertainty created by GoI and RBI on fiscal situation and quantum of OMO sales respectively. RBI concluded its OMO sales at a time when situation had already gone out of hands. Similarly, GoI had also created lot of uncertainty regarding the fiscal situation and that prevented risk taking in fixed income market. Actual fiscal slippage and incremental supply was not that much but the uncertainty from September to December kept the risk appetite muted during that period.

We feel that now Government has become more proactive and are really concerned about the recent spike in yields. As per recent comments in media, they are working closely with RBI in trying to calm the market and revive the SLR demand.

India is still a nascent market in terms of debt. What policies or interventions from the part of government will revolutionize growth in this asset class?

When compared to global markets, I think three main things which are missing from our market are: lack of forward curve, no market for CDS which can allow development of corporate bond market and lack of retail participation.

For forward curve, we need more instruments like interest rate futures and interest rate options. And policy makers will need to incentivize market makers in these instruments for market to pick-up. Similarly for CDS. Currently retail participation in fixed income market is primarily through fixed deposits. Policy makers need to incentivize retail investors for increasing their participation in the broader fixed income market.

During 2017, we could see more upgrades than downgrades in corporate bond segment. Looking at current developments do you envisage an adverse trend reversal?

Broader economy is picking up as indicated by stronger GDP print, latest IIP numbers and PMIs. In addition, high frequency data also indicates robust growth recovery in place. In this kind of environment, corporate balance sheets tend to improve and hence we are seeing more upgrades than downgrades. Going forward, with stress on bank balance sheets due to NPAs and unveiling of recent frauds, there may be some credit rationing which will act as a head-wind for the underlying momentum but we don’t think that is sufficient to change the underlying trend.

What is your advice to retirees in managing their corpus to earn a decent monthly income?

We think, for retirees it is prudent to look at safety of corpus first, then liquidity and lastly returns. The return expectations must be set accordingly. In pursuit of chasing higher monthly income, one should avoid buying greater risk, which might erode capital in an unfavourable cycle. Also, one should look at longer term stability while deciding asset mix, and not be perturbed by short market bouts.

What is your advice to youngsters who wish to enter debt fund investments? How to find the right allocation, manage that allocation and follow the market events?

Having fixed income allocation balances portfolio and provides stability. I think everyone needs to have some exposure to fixed income (debt funds). Like any other asset class, even debt funds have risk entailed, primarily interest rate risk and credit risk. While managing allocation across debt funds, one could look at adding interest rate risk at earlier stages and gradually switch this into regular accruals as age progresses. While managing such allocation, one should also keep in mind the broader cycles (macro factors have more bearing on debt funds) and avoid adding /reducing risk that is not commensurate to longer objectives

Out of your short term and medium term schemes, which one do you recommend now and why?

On a medium term basis, we are currently neutral on duration. There may be tactical opportunities on the duration part of the curve but a secular rally is not there. We believe that policy rates will be in phase of prolonged pause going forward, this may present opportunity in the short-end of the curve (steepening bias) as short term rates had also hardened significantly and with no immediate danger of rate hikes, this might present a good risk return trade-off. Therefore we recommend, short-term schemes in current environment.

How will debt funds fare after the latest introduction of LTCG tax on equity gains? What are the opportunities and challenges?

I do not think LTCG tax on equity would have material impact on debt funds’ performance. There could be some investors who might incrementally allocate more towards fixed income as tax efficiency would have some bearing on overall post-tax risk-return trade-off.

Like any other micro or macro changes, taxation as law of the land, should not be the only deciding factor while making allocation decisions. The opportunity and challenge here again will lie in identifying prospective risk-return paradigm and managing expectations.




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