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2 reasons why fixed income looks attractive now

Manish Banthia, Fund Manager, ICICI Prudential MF


10th March 2017

In a nutshell

In the last 3 years, whenever real rates have gone up, it has been an opportunity to invest in fixed income. We have one such opportunity now.

Never before has the target inflation differential between US (2%) and India (4%) been as low - there is a strong case for spread compression and therefore for yields to come off in India over time.

Volatility is not new in the fixed income space, and should not deter investors. Rather, volatility harnessing products like ICICI Prudential Long Term Plan should be considered to reap the benefits of the asset class while controlling volatility.

WF: Markets are fretting about the end of the fixed income Bull Run after RBI's surprise decision, but you have a different view - in that you believe the cycle has got extended and not terminated. Can you please explain why?

Manish: With a hawkish stance taken by the RBI, the fixed income cycle looks to have extended. In the current scenario, we believe the RBI being cautious with monetary policy is a constructive step for the fixed income market from a medium term perspective. Given that RBI is firm on its inflation target of 4%, we see an extended fixed income cycle in India, since the real rates in India are still high. We do not see the current phase as an end of fixed income Bull Run, but would consider it an opportune moment to consider investing in fixed income.

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Over the past three years, whenever real rates have gone up, it has been an opportunity to invest in fixed income space. Clearly the current increase in real rates can be another opportunity to invest.

We have to understand that every asset class goes through various cycles. We were of the view that a dovish RBI in October and November 2016, essentially meant that the fixed income cycle was in its final stages. But now, with a hawkish stance, the fixed income cycle looks to have extended.

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WF: How will a rising USD and rising US interest rates impact your rationale of a cycle extension?

Manish: Since US treasury rates have moved higher by 80-100 bps from pre-Trump era, market concerns are already priced in the US yield curves. Therefore, the outlook on US rate is neutral at this point in time. Having said that, RBI too changed its stance based on their call regarding global rates moving up. With US targeting an inflation of 2% and India targeting inflation of 4%, never has the differential been so low, which means the spread between US and Indian treasuries have room to compress further. Given that RBI is already cautious on the possible rise in interest rates globally, we do not see a reason to worry on that front.

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WF: Distributors who have been aggressively pushing debt funds to target swelling savings account balances post demonetization, have become a little circumspect after the recent bout of volatility. In light of current market conditions, what would you recommend as the most suitable product categories within fixed income funds to recommend in this context?

Manish: The market has been volatile for the last six months, more so after demonetization. Instead of worrying about the resultant volatility, investors should view this as an opportunity to take advantage of. As a fund house we have volatility suite of products, offered across equity and fixed income, which is suited to take advantage of the opportunities in volatile market conditions.

Specially, in case of debt, we have ICICI Prudential Long Term Plan which is dynamically managed and tries to trade the volatilities of the market and generate returns. This product has thus far offered better investment experience through lower risk, and risk adjusted returns over the long term.

Even during demonetization, the product was able to take that as an opportunity and generate return. For instance, pre demonetization ICICI Prudential Long Term Plan modified duration was around 5-6 years and increased duration to 8 years post the announcement of demonetization. In the euphoria of demonetization, the fund could reduce maturities as market became expensive. As on date, the fund is again increasing maturities as the market became cheap again.

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WF: Is there a tactical opportunity in duration funds now post correction or is that space best avoided?

Manish: As discussed earlier, the debt cycle seems to be extended. There can again be an opportunity to invest in debt funds and we continue to recommend dynamic duration schemes for investors with a three year horizon.

WF: Some experts believe that dynamic bond funds took a hit as most of them were not positioned appropriately for the RBI's surprise decision. Is sticking to accrual funds the prudent thing to do for retail investors or is there still a good case for dynamic bond funds?

Manish: It is very likely that in the near term fixed income markets are likely to remain volatile. The only class of fund which can take advantage of this situation is dynamic duration schemes. Hence, we are recommending investors to opt for ICICI Prudential Long Term Plan which can be an all season product for core debt portfolio allocation. The benefit offered by such a fund is 1) Take advantage of cyclical plays in interest rates and 2) Aims to generate alpha out of market volatility, which becomes an important trait to benefit out of volatile times.

WF: What do you see as the key risks of investing into the extended cycle now?

Manish: The risk currently is only if there is a change in Policy stance midway and thereby jeopardizing the fiscal math.

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