The Mutual Fund Show: Is It Time To Consider Gilt Funds As Yields Rise?
As the yield on the benchmark government bond rises beyond 7.5%, should investors consider gilt funds that invest in such instruments or long-duration debt funds? Or should they wait as the Reserve Bank of India is still in the rate-tightening mode to contain inflation?
"Let's wait-and-watch before we rush in and look at some of these gilt funds. They can be volatile,” Kartik Jhaveri, director investments, Transcend Capital (India) Pvt., told BQ Prime’s Niraj Shah on The Mutual Fund Show. “Where the rates have been rising ... there is a good chance that the investor can even lose a couple of percentage points on capital.”
A rate hike pulls bond prices down, dragging the net asset value of schemes.
According to Vishal Doshi, partners, Alpha Investment Managers, the best time to invest in a long-dated bond or a gilt fund is when the rates are actually coming off.
As of now, the RBI is still in a hiking zone, so he recommends that investors look at gilt funds with a horizon of two to three years at least, if not higher. “Investors can come in this kind of funds in a staggered fashion, in a three-to-five-month period.”
Jhaveri recommends a couple of fixed income options. “A pensioner or a senior citizen can consider annuity plans and pension plans because there, once the money is invested, then there is almost sort of a guaranteed lock-in that the money is going to be in for a long time and the investor is getting an annuity paid out.”
For the medium term, investors might have to do with some 'AAA' rated corporate deposits and things like peer-to-peer lending, he said.
Edited excerpts from the interview:
The long-term G-sec or long-term rates are closing in, at least on the fixed income side, around the 8% mark. Is it a good idea for somebody to invest in a long-term bond or fund which has that kind of instrument in its portfolio and is giving near about 7.5-8% returns currently, because this may not last? Or is the timing still not right?
Vishal Doshi: The best time to invest in a long-dated bond or a Gilt fund is when the rates are actually coming off. The market obviously always discounts the future, but in the present scenario, the RBI is still in a hiking zone.
The RBI has already hiked rates by 90 basis points, and we may still see further hikes. Having said that, the 10-year G-sec has already moved past 7.5%, which is a fairly crucial level to see from a longer-term perspective.
So, investors can start looking at Gilt funds, but with a horizon of 2-3 years at least, if not higher.
And another aspect which investors should keep in mind is that the geopolitical situation is still very fluid. We are uncertain about the war, as well as uncertain about where this inflation peaks.
So, investors can come in this kind of funds in a staggered fashion. In a three-to-five-month period, they can come into such kind of long-dated Gilt funds.
Karthik, what's your opinion? Some people were saying that if you have a 30-year view–from a retirement perspective–when will you get 8% returns on a fixed income product? So, try and lock-in something like that. What's your sense around this topic?
Kartik Jhaveri: The argument is compelling that while you see a number like 7.5% or 7.8%, it is extremely enticing to sort of lock it in. But we have seen this in the past, we have seen regimes, we have seen time periods where the rates have been rising. What happens immediately with the Gilt fund is there is a good chance that the investor can even lose a couple of percentage points on capital. Now, once you lose even 3-5% on your capital–because as Vishal rightly pointed out, we probably don't know if the rate hike cycle is done yet and we are somewhere in the midst of it.
Maybe, there could be another one or two rate hikes also, depending on the international situation. So, my sense is that if you get into a Gilt fund, and if you are down by 5%, it might take you a year or two just to recover, and that may not be one of the best things to do.
So, I would maybe look at the whole situation, how the whole thing pans out. Maybe six months down the line we will have better clarity, and then when we see that the interest rate seems to have stabilised, that would be a good time to get into Gilt.
So, Vishal said 3-5 months, I would quite subscribe to that concept and that methodology of buying, saying 'Let's wait and watch before we rush in and look at some of these Gilt funds'. They can be volatile. We have seen capital losses also in the past decade or so. We have seen this kind of situation. So, I would not recommend to rush.
For somebody who has got money but does not want to put it in equity funds and wants to stick to asset allocation between equity and fixed income, what is the fixed income option?
Kartik Jhaveri: There are a couple of fixed income options, right from a short term to a medium term to a long term. Now, if it's a pensioner or a senior citizen, let's say if he's got a sizable amount of money, he can consider annuity plans and pension plans because once you have invested the money, then there is almost sort of a guaranteed lock-in that the money is going to be in for a long time and you are getting an annuity paid out. So, that might be one of the longer-term options.
Let's say somebody wanted to lock it in for 10-20-30 years, then annuity plans are a good option. Now, the moment the rate hike happens, these annuity plans also revise their rate upwards, and that's a good opportunity for them to get into. In the medium term, you might have to do some AAA-rated corporate deposits and things like that.
In the short term, there are things like peer-to-peer lending which you can consider to a small extent. In fact, there is a lot of noise and knowledge around the whole thing which is kind of intertwined with each other, but I think that is an interesting option.
Vishal, what would your thoughts be for somebody who only wants to invest in a fixed income option?
Vishal Doshi: One of the options which I actively look at is AAA-rated bonds. Bonds of large corporates are a safer bet and offer good yields as well. That is from a medium-term perspective.
What would the yields be, Vishal?
Vishal Doshi: AAA-rated will be anywhere around 7% or 7.25% types–there is a good chance to get that kind of yield. For somebody who wants to take a slightly higher risk, they can go for MLDs or Market Linked Debentures, which are also 100% debt-oriented, but definitely not AAA.
But yields will be much higher, around the range of 9%-9.5%. So those are two options, plus the classic corporate deposit, which is very popular with retail investors as well as HNIs. That is one option where corporates like PNB Housing, HDFC, Bajaj Finance, all of them have their corporate deposits.
So, these are the options plus now some exotic debt instruments are also coming into the market. Some are related to green energy or bill discounting, and these can be looked at. But, obviously, it's a smaller portion of the entire portfolio. These are the only options available for debt investors.
At some point in the past, Parag Parikh had taken this option or approval to do a covered call strategy. We now have the DSP Quant Fund do it. A couple of other funds have done it as well. A lot of people, when they see an email coming in, wonder why is the fund doing it, and is the fund still remaining within the same risk parameters? How would you respond to that?
Kartik Jhaveri: It definitely changes the risk element, maybe not by a huge margin, but there is a difference there.
What's happening is that these covered call options, which some of these mutual funds might take, are done to increase the return on their investment.
Basically, there will be a time, and there is always a time where sometimes the stock market doesn't move or a stock doesn't move. It moves sideways. It's in what we call a sideways moving market that goes up maybe 5%, comes down by 5%, but it's in a band of sorts.
Now, in this situation, wealth growth or appreciation doesn't happen. So, what they do is they sell options. When they sell options, they get a premium. So long as the market remains in that sideways band or in a particular zone, the fund tends to make a little bit of extra money. It’s income to the fund and therefore, positive benefit to the NAV and therefore, to the investors.
But having said that, there could be instances where the markets–like what we saw a couple of days back–suddenly has a 500-point drop or like a 3%-4% movement. Now, at that point of time, stop losses for the funds also would get triggered like retail investors. There could be unnecessary loss, that kind of a thing. So, that is what these covered call options can sometimes do.
Does it change the risk-o-metre? Maybe yes, marginally, it does change it. But, does the strategy of the funds change radically? Absolutely not. Since you mentioned Parag Parikh, their objective is long-term equity growth and that's exactly the name of the fund also, then it will stay intact.
I mean, all the fund managers would like to do that, but they are trying to augment the returns of muted times or times where the NAV will not change dramatically.
So, it's not a bad idea as long as it is done within some controlled parameters and within a predefined set of limits, which I am sure they are doing.
Investors need not worry too much about it. It's not a bad idea, but remember, there is a risk to it. If the market suddenly stands upwards or downwards, either ways there could be a loss.
Vishal, do you get worried or nervous when funds do this? What's been your experience and what would you tell your clients if they were to ask you this question?
Vishal Doshi: Definitely, when any scheme indulges in derivatives, the risk will go up by a notch for sure–howsoever safe the strategy might be and howsoever lower the limits might be of doing such a thing.
A covered call is actually a derivative strategy where the investor is basically writing call options on a stock which they are already holding.
In a scenario where the market really shoots up by say 5% in a couple of days or in a day's time, there is a chance that such a fund might end up even making some kind of a loss, although they have a cash position to that extent, but derivatives will not move by that much margin. So, there is a good risk that there might be a loss in such a strategy.
I would rather not have a fund doing this. I would rather be happy with pure, long equity kind of portfolio and look at other ways of doing these covered calls or other derivative strategies.
If your clients had any of these funds in the portfolio, would you go so far as to tell them to move out of those funds and move into other funds because of this?
Vishal Doshi: Not exactly tell them to move out, but definitely, I will tell them to be cautious on these kinds of funds.
Here is an investor who is looking to invest for the long term. She has a high-risk appetite, and she has the longer term thought process in mind. What would you advise her to do? What kind of funds can she put money in and why?
Vishal Doshi: If the investor is a high-risk investor and has a sufficiently longer-term horizon, say at least 5-7 years, I would advise pure equity funds, which would be in the category of flexi caps, mid caps and small caps. I am very clear on that, that the India story is here to stay. If an investor has that kind of appetite, then he or she should go for such kind of funds.
If you are recommending flexi cap or mid cap or small cap, and this may not be an exhaustive list, but can you share one or two names out of the many that you may be recommending?
Vishal Doshi: Investors can look at say a DSP Flexi Cap Fund or Franklin Flexi Cap Fund or say a long-standing fund like the Nippon India Growth Fund, or maybe in the small cap space something like ICICI Prudential Small Cap Fund or Canara Robeco Small Cap Fund.
Is there a reason why you like some of these funds versus the others?
Vishal Doshi: Some of these funds do have a long history. For example, Nippon India Growth Fund has a long history and DSP Flexi Cap Fund has a long history. So, these funds have shown performance in the past and they have good fund managers to help them.
Kartik, the same question to you. This investor has got a long-term horizon and a large risk appetite. What would you advise?
Kartik Jhaveri: For her and for everybody else who wants to do something different, the standard operating procedure remains the same–buy your large cap, buy your mid cap, buy your small cap, buy some flexi cap.
Out of the entire Rs 100 that is going to be put to a mutual fund, I like to tell my investors that think about 30-40% into play sectors, play themes. For example, in 2020, post Covid, the theme that was to be played and which we did play was the pharma theme. Investors made a huge amount of money, they made huge gains in pharma. So, pharma was a suggestion made and investors accepted it. I think history shows us that pharma did superbly well.
So, in that sense, there are always periods and phases where one sector or the other might be shining. For example, commodities is another very interesting space, infrastructure is an interesting space–infrastructure from a domestic as well as an international point of view, commodities more from an international than a domestic point of view.
If we start looking at things like food shortages, what happens as a result of all this is there is a lot of latent demand for a lot of these products. So, we will supply steel. Our steel manufacturing companies will export a lot of steel. We will export sugar.
Although, there have been temporary supply-side economics playing in, and as a result of which the government has had some policies. But that is not a permanent thing. So, if you want to play an interesting and a sort of powerful theme, there are commodities, infrastructure, etc.
Banking, for example, is a theme, which has not played out for a long time. So, somebody like her might want to consider a banking fund. Every other sector has gone far ahead than the banking sector.
As a bank, you are going to earn more interest when the interest rate goes up, all our home loans and all the rates go up. When they move up, banks make money and that's the time one should consider things like that.
Look at the U.S. market. It has fallen dramatically, much more than our markets. So, there is S&P, there is Nasdaq, there is an international theme to do. Again, there's some RBI embargo on that for the time being, but it's not going to remain forever and perpetually. International is also a theme that you might want to think about.
These are things you can invest 30% to 40% of your mutual fund portfolio–one could be a little more active than the usual one. So, 70% let's say you have your flexi and mid cap, large caps, small caps. These are traditional funds, we keep them and we hold them, match with our financial goals and so on and so forth. But another 30%, you can play on these interesting themes and ideas.
If somebody is wanting to play the banking theme, what are the funds that you recommend?
Kartik Jhaveri: I don't like to endorse any particular fund. But having said that, banking or pharma or real estate or commodities–virtually every fund house has got some funds and their performance is almost equal to each other.
There are resources that investors could look up and consult your own advisors as well.
Everybody has these themes, but these themes have much smaller AUMs compared to the AUMs of funds, like the pure blue chips and the pure large cap funds.
But these are places to actually explore to get that additional alpha that you might be looking at in your portfolio.
If you are prepared to take a little bit of volatility, these are the places to go.