The Mutual Fund Show: What Fixed-Income Investors Should Do After RBI's Latest Rate Hike
While yields won’t move that much in the long term, in the short term they are going to rise.
Investors should not change their outlook on fixed income funds even as the Reserve Bank of India hiked the benchmark rate again, according to Finsafe’s Mrin Agarwal and TBNG Capital Advisors’ Tarun Birani.
“There is a little bit of rate hike still left, but if you are looking at it from a long-term perspective, I don’t really see long-term yields moving that much,” Agarwal, a financial educator and founder of Finsafe India, told BQPrime’s Niraj Shah.
The central bank increased the benchmark repo rate by 35 basis points to 6.25% as India’s inflation remains elevated.
Birani said the hike was in line with the global inflationary scenario. “The way inflation has been sticky in the past, I feel the RBI's move is more or less in line with what our expectation was,” he said.
While yields won’t move “that much” in the long term, in the short term they are going to “move up, given what's going to happen on the repo, but it's not going to be very drastic,” Agarwal said.
The fourth tranche of the Bharat Bond ETF, which closed on Dec. 8, is a "very beautiful structure" for investors with long-term fixed deposits or who are retired, as it offers a yield to maturity of 7–7.5%, according to Birani.
"If you look at the lineage of Bharat Bond in the past, they have been positioned like very low-cost, debt index products in the market, which is definitely a very investor-friendly product in the current environment," he said.
However, he warned that it “comes with volatility in between periods.” Agarwal underscored that the ETF is not going to give regular income annually.
The IIFL Tax-Saver Index Fund, which is still on sale till Dec. 21, is "an option to watch,” said Agarwal, adding that she would continue to watch for the “tracking error” on the passive fund.
As the fund is a “cheap product,” it can “balloon like a very big category going forward and for the investor," Birani stated.
Watch the full conversation here:
Edited excerpts from the interview:
Mrin, does the RBI move and the commentary thereof change your outlook or your recommendations on fixed income funds in any fashion?
Mrin Agarwal: First and foremost, not really. There is some little bit of rate hike still left but if you are looking at it from a longer-term perspective, I don’t really see longer-term yields moving that much.
If you are looking at things over 7-10 years, yields are not really moving that much in the longer-term and of course, shorter-term is going to move up, given what's going to happen on the repo but it's not going to be very drastic.
We shouldn't really try to always time it for the highs. I mean, if you do have money to deploy in debt, you should start deploying it.
Tarun, has your view changed in any fashion?
Tarun Birani: Not really, I think RBI move is in line with how global things are moving and as well as in India also. The way inflation has been sticky in the past, I feel RBI move is more or less in line with what our expectation was.
As rightly shared by Mrin, long-term interest rates are more or less, you can see, topping up and that's where I feel from an opportunity point of view, people can start looking at long-term debt investing in a much more serious manner now, because the India growth story continues to remain intact.
And as we are moving into a developed market, going forward, I think interest rates should start going down from a longer-term point of view. So, it would be a good strategy to look at longer-term debt.
Tarun, are you locking in some really long-term debt investments at the current juncture?
Tarun Birani: Primarily, we invest our long-term debt in instruments like PPF, EPF, that is our long-term debt. If you ask me the products competing against these PPF, EPF, all these 20 or 15-year G-Sec bond funds available in the market, they definitely offer a very good opportunity right now.
Unlike the illiquid nature of EPF or a PPF, you get complete liquidity here. At the same time, let's say if you are an opportunistic investor or a tactical investor and tomorrow, let's say a 200 basis point rate fall happens, you can book in that capital gains also, apart from the capital indexation benefit.
So, definitely, it's a very interesting thought, but it is for somebody who is a little more understanding about this, that as the interest rates will come down and it can go up also for that intermittent period.
Let's say if I take an example of a 15-year G-Sec security portfolio, if the interest rates go up by say 100 basis point, with the duration of say 15 years, you can see a very high mark-to-market happening in that portfolio. But if the investor is aware and very well-educated that it's a target maturity fund, come what may, it is like a fixed deposit that lasts for 15 years if you hold till maturity and if you have logged and the portfolio manager is not actively managing it. Apart from the impact cost here and there, you are going to make the returns what you have logged in at that time.
So, my thinking is more from a behaviour perspective, how investors will react to these ups and downs in the debt markets, which I think people are not very much aware of. They just see the past returns have been year-to-year and based on that they enter into the debt markets, which I don't think is the right approach.
Mrin, is there a mutual fund route to this, what kind of returns that might come in something like this and what should one keep in mind while doing this?
Mrin Agarwal: Tarun spoke about the open ended, market length return funds and the risks that you have there in terms of being suave enough to understand about what happens during volatile times.
So, of course, now you do have a whole lot of target maturity funds that are there as well, which have a bit more surety on returns, provided you are very clear about your investment horizon.
So, today, there are two sets of funds. You have these funds where you have a little bit more surety, but also a little bit more illiquid because you need to be clear that you want to be there for that particular period. I don't think that most retail investors have the wherewithal to really go and trade these funds in the exchanges and stuff like that. So, to that extent, I feel you need to be very clear.
Of course, again you have the rest of the funds that are there like the short duration debt funds, dynamic bond funds, a whole host of funds of course, which gives you market-linked returns and which are open to all sorts of interest rate movements and so depending upon your entry and exit, it depends upon the returns.
Then, you do have fixed income securities that are available, for example, directly buying G-Sec bonds, but those don't really turn out to be tax-efficient.
Mrin, I have a horizon northward of 15 years, should I buy a debt fund at the current yields? What is the option available and what is the kind of return that I will get, if I hold to maturity?
Mrin Agarwal: Okay, I always like short duration debt funds, and I know you mentioned a very long-term holding period of 15-20 years, but I like short duration debt funds simply because the risk-adjusted returns are the best in short duration debt funds when you compare them to the other funds. Of course, if you can take volatility, even the long duration gilt funds are also an option that's available to you.
What are the returns there?
Mrin Agarwal: If you are looking at forward returns because you are going to be looking at forward yields going on from here, the returns that we are talking about are still going to be in the range of about 7-7.5%. Maybe if you are smart enough to do some good calls of entry and exit, you might make some little extra. On an average, that's the sort of yield that you are really looking at.
Tarun, same question to you, a long duration mutual fund option for somebody who's willing to stay locked in?
Tarun Birani: So, provided the investor is very well-informed and aware of this interest rate volatility, I think long-term definitely offers a very good opportunity.
But I would also look at more of a laddering approach. I will not go and pick up everything in the 15-year thing, maybe I will try to divide that money, in a five-year, seven-year, ten-year, 12-year, 15-year so that laddering will definitely give investor a much more balanced experience and a better experience over investing for a long period of time.
So, maybe one can look at laddering approach, but as Mrin also mentioned, five years, six years or four-year is also available at a very attractive rate right now. So, if investor is not very sure of a 10-15 year thing, maybe they can look at a target maturity fund of a 4-5 year horizon. That is also very attractive right now.
One example could be the Bharat Bond ETF; the fourth tranche is open right now. Have you looked at it at all and what's the kind of return anticipated and what kind of investor should go for it?
Tarun Birani: So, the investor from a suitability point of view, I think it's a very interesting product. If you ask me, pure debt-oriented investors who used to invest into long-term fixed deposit or retired savvy retired people—again, I am talking about savvy retired people who understand the volatility of the interest rates is going to affect the portfolio intermittently.
That's a very, very beautiful structure for them, from a long-term point of view, because they are locking in the interest rate of, I think, 7-7.5% plus as we talk right now on the YTM front. So, this is a very interesting YTM to look at.
It is basically a portfolio of PSU bonds only, ‘AAA’ PSU bonds, which I think more or less has a Government of India guarantee available for them. So, it's a fairly safe and secured structure from that point of view.
If you look at the lineage of Bharat Bond in the past, they have been positioned like very low cost, debt index products in the market which definitely is a very investor-friendly product in the current environment. But investors need to be careful of the negatives also that it comes with volatility in between period. So, if they are ready for that, please go for it.
Mrin, same question to you and what's the time duration? I mean, because a lot of people talk about investing in these funds with a target year in mind?
Mrin Agarwal: Yes, so the duration is about 10.5 years and just adding on to what Tarun said, I think he covered most of it, it's really meant for people who are very clear that they want to hold an instrument for this particular period. The second thing is that they need to be very clear about the fact that they are going to get the returns cumulatively.
It's not going to give them like a regular income or a regular pay out on a yearly basis. So, as long as you are clear about that, I think it's a good product to get into. It is giving your expected 7% post-tax return, which to my mind, is a good return at this point in time.
Now, the last question is on the IIFL Tax-Saver Index Fund where the NFO is open. Mrin, an index fund with tax saving benefits, is this a good option?
Mrin Agarwal: I would say it's an option to watch. I wouldn't say yes or no right now, because what's very important in any passive fund is the tracking error. We need to wait and watch the tracking error and I mean the concept sounds good, you know, having a passive fund.
But two-three things that one has to keep in mind is, what is the index the fund is following, because in this particular case, you are following Nifty 50. So, it's basically a large-cap index. Typically, most of the other actively managed ELSS schemes do have mid-cap and small-cap exposure as well.
So, when you look at the category average returns of the ELSS category itself is better than Nifty 50 returns. And, of course, there are funds which have got a good outperformance and provided a good alpha as well and provided good risk-adjusted return. Hence, I would say right now I would just wait and watch. See how the tracking error really develops on this.
Tarun, what's your view here?
Tarun Birani: I feel it's a very interesting category development which is happening. And if you look at the way income changes are happening in our country, I don't clearly remember the income data but what I remember is, we have almost two crore plus individuals who are filing more than Rs 7 lakh, Rs 10 lakh of income every year and for them 80C is a very important category to save and invest Rs 1.5 lakh every year. Most of them don't understand the volatility of equity markets and they end up putting the money into PPF and all the other safer instruments.
If you are able to convince investors of the benefits of long-term equity, as well as a Nifty-kind of structure, which has a much lower volatility, standard deviation is lower, it's passive investing.
The cost I was looking at is it's a 25 basis point in direct plan, 50 basis point in regular plan, it's a very cheap product. If you look at the last 10 years of Nifty performance is 12% IRR on an annual basis which to my mind is a very interesting compounding story and ELSS is something which is like a recurring regular money which keeps coming in.
If this category develops, it can balloon like a very big category going forward and for the investor, it's definitely a very positive thing. As you have seen, 80% of the large-cap funds are not able to outperform the index. The need for a passive fund is definitely there.
Is this a good option for a person who wants to invest in ELSS scheme or is it a good option for a person who wants to invest in a large-cap Nifty ETF? What is this a good substitute for?
Tarun Birani: So, it's a very good category for core portfolio development and a good habit development for a first-time investor who is trying to do tax saving. Index investing will give him a far superior performance.
Let's say if I look at active funds, last five years if you look at, every year the winners are changing. But for me, Nifty is going to be more or less similar, so that is one very stable thing and a durable thing.
My suggestion is, if you are looking at building a long-term core portfolio, it could be a good recurring investing category which you are developing. I like things which are very simple. I don't like things which are very complicated. Every morning, if I have to wear the same dress, it's very good for me. Every year I know I have to invest in Nifty, I put my SIP in the Nifty index fund and it goes for 10 years.
So, it's a very positive development for investors. Anybody who wants to develop a long-term habit and I know investors have index in their portfolio but again, they can look at other active funds because there you have options to invest into.
One argument is that in ELSS funds, since there is a lock-in, you can buy more mid caps, small caps and all these things that can help you generate better returns.
So again, it depends on the risk profile of an investor. If as an investor, your risk profile is high and you are ready to bet on that, there are ELSS, but I feel most ELSS funds have 50-60% into large caps only, as we talk.
Mrin, assuming that somebody is going direct, is it better to maybe go for these or are there some with even a lower expense ratio because here are the advantages of tax benefit. But an investor might be getting the tax benefit out of traditional investments like insurance or for that matter a PPF, which the investor might still anyways continue?
Mrin Agarwal: So, if we just keep the tax benefit aside, which is what you are saying, let's say the tax benefit is already utilised by some other investment, should one do this just as a pure investment?
I would again say it all depends on the tracking error because today when you look at certain low-cost index funds that are there, they do come with a higher tracking error than a fund with a slightly higher expense ratio.
In any index fund, I would always say that it's a play of two things: one, the index that you want to go with, and the second thing is the tracking error. So I just feel that, people already have a lot of index funds in their portfolio and then by buying another ELSS fund, which is going to be tracking the same index, is not really going to give them diversification and it's actually going to get them more concentrated towards certain sectors and towards certain stocks. So, all of these are not in the favour of recommending this right now.
But I do see a lot of investors being very confused about what ELSS to buy and if you are not sure, this gives you an easy way out. But remember, you are going to be concentrated in sectors and stocks because of your overall exposure to the index.
Mrin, what is the fund with a bad tracking error?
Mrin Agarwal: I think the tracking error below 0.1 would be a good number. You don't want a very high tracking error. The tracking error is because of two reasons: one is the expense ratio and the other is how good is your ability to deploy the funds. So, today, we are seeing the tracking error differences happening mainly because of that reason.