‘Short-term debt funds focused on corporate paper will perform’

Santosh Kamath, chief investment officer (fixed income) of Franklin Templeton
Mutual Fund, feels investors should stick to their financial plan rather than getting
perturbed by short-term fluctuations in rates. In an interview with DNA,
he said Indian retail investors should recognise the tax advantage factor while choosing debt instruments for investment. Excerpts:

The short-term rates have eased substantially. Do you see more easing?
The recent easing in short-term rates had come after the spike witnessed in the March quarter, due to the financial year-end factor along with government cash surplus and ongoing monetary tightening. While systemic liquidity has eased in April, we don’t foresee any substantial decline as RBI’s tightening bias continues and credit growth remains high.

Franklin Templeton’s survey identified that patience and timing are the two most important factors for successfully investing in stock market. What are the key factors for successfully investing in debt market?
The basic investment principles apply to fixed income investing — patience and discipline. Typically, fixed income funds are grouped by the maturity basket in which they invest. An investor is recommended to invest in them keeping the investment horizon in mind. We recommend investors to stick to the financial plan and not get perturbed by short-term fluctuations in rates. Additionally, for Indian retail investors, it is important to recognise the tax advantage factor while choosing debt instruments.

Inflation continues to be the biggest worry for Reserve Bank of India (RBI). Where do you see it heading in 2011?
While inflation levels appear to have peaked, it is expected to remain elevated compared to the last decade on the back of structural changes — rising income levels driving changes to consumption patterns—as well as rising international oil and commodity prices. The near-term inflation outlook will depend on trends in global commodity prices and monsoon. The government needs to step up efforts to plug supply side gaps and infrastructure bottlenecks to provide stability over the medium-term.

Central banks around the world are increasing interest rates. What are your views on movement of interest rates globally? Do you think Indian firms planning to tap the international market for fundraising will be at a disadvantage?
The tightening bias is predominant in the emerging markets and we have recently witnessed a rate hike by European Central Bank too. However, global liquidity levels continue to be high and the wealth transfer from oil importers to the exporting countries could boost liquidity in the asset markets. Given the continued risks to growth from de-leveraging and the still nascent recovery in labour markets, central banks in developed markets are unlikely to tighten rates substantially. In that sense, Indian corporates with access to international markets may continue to benefit from raising funds abroad due to high interest rate differential.

The recent extension of liquidity management measures by RBI was completely unexpected. Why do you think RBI did it? What is your outlook on liquidity in the near-term?
While systemic liquidity levels had recovered from the excessively tight situation witnessed in March quarter, liquidity could remain under pressure due to high credit offtake along with the ongoing government borrowings programme. Liquidity conditions are likely to be more dynamic (bi-directional) as the year progresses, in line with the RBI’s monetary/liquidity stance.

What is the outlook on the bond spread  in the near-term?
The five-year corporate bond spread over gilts has widened over the last quarter due to a combination of factors including liquidity tightening and rate hikes. Corporate financials by and large remain on a strong footing and the same is reflected in the improvement in modified credit ratio (MCR). It has moved up to 1.1 in FY11 from 0.93  in FY10. Bond spreads should continue to remain around the current levels unless corporate earnings news flow worsens. Any sharp increase in government borrowings will also have implications for private borrowers.

Which debt fund categories do you feel will outperform in FY12?
In our view, short-term debt funds focused on corporate debt and accrual are likely to perform well in the current macro-economic environment over the medium term. Once the interest rate cycle turns, funds focusing on high accrual will benefit from coupon payments as well as capital gains. We remain cautious about yields at the longer end of the curve due to oil prices and possible fiscal slippages.

Is there any new fund offer in the pipeline for debt segment?
We have always focused on meaningful products with a unique proposition and we are evaluating few products focused on the corporate bond segment.