An investor can take medium term calculated calls to tap the scope of capital appreciation

What is your outlook on inflation and interest rates? When do you see interest rates peaking, globally and here in India?

The worst of inflation seems to be behind us domestically and in major global economies. Inflation in US has come down from the highs of 9.1% to 6.4%. However, it still remains materially above the target of 2%. Similarly, in India inflation has cooled from the highs of 7.79% to the latest print of 6.52% (January 2023). RBI’s inflation projection of FY 2024 stands at 5.3% which is within the target range of 4% ± 2%. However we need to be wary of risks that can have an upward bias on inflation like strengthening of growth metrics due to China reopening, rise in prices of commodities etc. With regard to interest rates, Central Banks have come a long way in the past year. Interest rates seem to be nearing the peak and our expectation is that by mid-2023 most Central Banks including RBI will announce a pause.

How much of the rate hikes is already priced in bond yields? What are your views on bond yields?

The MPC of RBI has retained flexibility by not making any pre-commitments to the future policy path. RBI will remain agile, alert and data dependent while making its next policy decision. Post the higher than expected CPI print of 6.52%, yields have moved higher as market now expect a terminal repo rate of 6.75% which has been priced in at current levels. However, demand and supply dynamics hereon will drive bond yields.

What is your fixed income strategy for different investment tenures - 1 year or less, 2 - 3 years and longer tenures (3 years plus) in the current interest rate environment?

Different investment tenure products have different investor goals that needs to be kept in mind. SEBI has categorised funds based on duration mandates. Yields on money market instruments and debt instruments are attractive at current levels. An investor should ideally invest into a particular category, based on his investment horizon and risk appetite. As we near a pause in interest rate hikes, investors with investment horizon of around 3 years or more could get attractive risk adjusted returns by taking active duration calls for a longer tenor.

Target maturity fund AUM crossed Rs 1.2L Crores AUM in December 2022. Target maturity funds (TMF) have now become the largest debt fund category after liquid / overnight funds. What, in your opinion, is attracting huge investor interest in target maturity funds over the past year or so?

There have been multiple factors that have worked for target maturity funds. The most pertinent ones are: volatility in equity markets in the recent past have made investors more cautious, investors have preferred to lock in to the existing interest rates The current yields with positive real rates has given further comfort to investors. However, given the current macro-economic scenario, we advise investors with investment horizon of around 3 years or more to look beyond TMFs. Investors can now invest at the prevailing higher rates and take medium term duration calls to keep the scope open for capital appreciation.

Many investors seem to think of target maturity funds as alternative investment options to Bank Fixed deposits. For the benefit of the layman retail investor, please explain for who and why target maturity funds are suitable investment options?

Target maturity funds are designed with a specified maturity date. Those investors who have a defined investment horizon and are comfortable with the prevailing yields for the said investment horizon, invest in TMFs as an alternative to Bank Fixed Deposits. Currently TMFs provide tax efficiency (long term capital gains tax if held for more than 3 years) as compared to Bank Fixed Deposits. Given the interest rate outlook, we advise investors with investment horizon of around 3 years or more to look beyond TMFs. Investors can now invest in mutual funds which actively manage duration calls to keep the scope open for a potential capital appreciation.

Based on our experience, the average mutual fund distributor is still focused largely on equity or equity oriented funds. On the other hand, the average household in India is still largely a fixed income investor, as far as the asset allocation of the household’s overall net worth is concerned. What is your advice to distributors on the potential of debt funds?

The potential of debt mutual funds is still largely untapped, especially in the retail segment. Mutual fund distributors need to focus on investor education and the client specific requirements and accordingly advice suitable products. Analysis of the domestic fixed income market shows a major part (~48%) of the market remains invested in fixed deposits. Hence, debt mutual funds have a huge untapped potential in the retail segment.

Many investment experts in electronic and digital media are telling investors that 2023 to be the year for fixed income. What are your views? What will your general advice to fixed income investors for 2023?

The year 2023 seems to be very promising for fixed income investors as real interest rates have turned positive due to rate hikes and tight liquidity conditions. Our advice to fixed income investors will depend on their investment horizon. Our general advice to investors is to invest in products which runs a duration in line with the investment horizon. An investor can also take medium term calculated calls for increasing the duration to tap the scope of capital appreciation.

Mutual Fund Investments are subject to market risk, read all scheme related documents carefully