- 4/1/2024
- Understanding the bond market
- Managing fixed-income portfolio
Alex Mathew in conversation with Mirae Asset Investment Managers' Mahendra Kumar Jajoo and AmitKukreja.com's Amit Kukreja.
- Managing fixed-income portfolio
Alex Mathew in conversation with Mirae Asset Investment Managers' Mahendra Kumar Jajoo and AmitKukreja.com's Amit Kukreja.
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TVTranscript
00:00 (upbeat music)
00:02 - Hi, thanks so much for joining in
00:14 to this special broadcast on NDTV Profit.
00:16 My name is Alex Mathew.
00:18 The start of a new financial year is a great time
00:21 to take stock of your investment strategy.
00:24 And we talk about equity on every other show
00:27 on this platform.
00:29 On this show though, we'll talk about fixed income.
00:32 And what are the factors that will cause interest rates
00:35 to move in the new financial year?
00:37 How much can you predict?
00:39 And most importantly, how can you benefit?
00:42 That's what we're covering today.
00:45 My first guest today is Mahindra Kumar Jaju,
00:47 the CIO of Fixed Income of Mirai Asset Investment Managers.
00:52 Thank you so much, Mahindra, as always for speaking to me
00:54 and for speaking to NDTV Profit.
00:57 Let me start with a coverage of the context
01:02 that we're in right now.
01:03 We're just about a week or less than a week, in fact,
01:06 away from the RBI's rate decision.
01:09 There's a lot that is playing out on the global,
01:12 in the global setup as well.
01:14 We're watching for the Fed
01:15 and when the next move is taking place.
01:17 So let's break this down.
01:19 Let's first talk about the global scenario.
01:21 And let's first talk about how you as a manager
01:24 of fixed income portfolios are looking at the Fed.
01:27 - Fed is very clearly inclined towards rate cut
01:34 in the second half of the year.
01:36 In the US, the inflation has come down significantly
01:39 from a peak of about 9% to now at about 3% to 3.5%.
01:44 It is still very far away from the Fed's target of 2%,
01:48 but then everything is pointing to continuous
01:51 (indistinct) inflation.
01:53 For example, the oil prices have not moved up meaningfully
01:57 in spite of so much of geopolitical tension.
01:59 So most of the commodity prices are pretty well behaved
02:03 to suggest that inflation should continue to remain benign.
02:06 And therefore, given the fact that in the last leg
02:09 of the inflation going up and the rate hike cycle,
02:13 the Fed moved very aggressively.
02:15 The last 100 basis points of rate hike that Fed did
02:18 from 4.5% to 5.5% is something
02:21 which is a very low hanging fruit for the Fed to reverse.
02:25 And therefore, I believe that in the second half of the year,
02:30 which is sometimes in June or July,
02:31 we should get our first rate cut from Fed.
02:34 And that's pretty much, I think the update also
02:38 seems to be discounted at one time.
02:40 - From the perspective of managing
02:44 a fixed income portfolio, I'm just curious,
02:47 and we'll talk about the investor perspective
02:49 also down the line.
02:51 But in a falling interest rate scenario,
02:54 is it relatively less challenging
02:57 than it is in a rising interest rate scenario
03:00 or are they both equal?
03:01 - I think markets are equally challenging.
03:07 So how many people you know who have reached
03:10 the big rally in the equities market?
03:13 So, you know, in a falling market,
03:17 the fear is of getting trapped
03:20 and not being able to exit in time.
03:22 In a rising market, there's a fear of missing out.
03:26 So I think the opportunities are on both sides.
03:30 Having said that, why it is easier for the fund managers
03:35 in India and particularly in fixed income
03:37 to have a falling interest rate scenario
03:39 is that, you know, everybody makes money
03:41 and everybody's happy.
03:43 We are generally a long only market
03:45 with a very limited number of players.
03:47 So when the interest rates are going up,
03:49 there are limited tools available for hedging.
03:52 We are typically a long only investors
03:55 as a mutual fund and therefore,
03:58 when the interest rates are going up,
04:00 our returns don't look that attractive.
04:02 So I think in that sense,
04:05 it is easier to have a situation
04:07 where the interest rates are falling,
04:09 but from a market perspective,
04:12 both are equally challenging.
04:15 - Let me add to that question then,
04:18 because there are people that watch this market
04:21 and I'm not talking about professionals like yourself.
04:24 I'm talking about people
04:25 that reasonably understand the bond markets.
04:28 And what they think is that
04:31 if they can predict the peak of an interest rate cycle,
04:35 and generally you have fair warning,
04:38 then you can't go wrong when you say, for example,
04:42 take duration at that period.
04:44 And if you have enough time horizon ahead of you,
04:47 because at some point or the other, you will make money.
04:50 Is that the right approach?
04:51 - I think that is an absolutely correct statement
04:57 that if you can predict the peak of the interest rate,
04:59 then obviously you're going to make a lot of money.
05:01 But I think that prediction is a very challenging thing.
05:05 It is very difficult because typically
05:07 when the rates are going up,
05:09 then people tend to think that it will continue to go up
05:11 and vice versa.
05:13 Now, there is another challenge that people need to factor in
05:18 that in US, for example, the income is inverted.
05:23 So, Fed is at five and a half percent,
05:26 the two year is already around four and a half percent
05:28 and the 10 year is at around four quarter broadly,
05:33 big numbers now.
05:34 And then the 10 year has moved in the region of 3.85
05:39 to four and a half percent for a brief while
05:42 to five percent in the last one year.
05:45 So, even if you call the peak of the Fed rate
05:49 at five and a half percent, right,
05:51 it has been close to now,
05:53 almost six months that Fed has not done anything,
05:55 market has done a lot of things.
05:57 There is a lot of missed opportunity in that sense,
06:02 or a lot of hit to the portfolio
06:04 that could have taken place in that sense.
06:06 So, I think being able to predict the peak
06:09 of the interest rate is just one part of the entire process.
06:14 Let me give you one example.
06:16 Last year, when the interest rate environments
06:19 were very, very difficult,
06:22 and we used to say to everyone who cared to listen
06:26 that look at around 7.5, 7.6, 10 year yield
06:30 in India seems to have peaked
06:31 and therefore it is a good time to start looking
06:34 at target maturity funds,
06:35 which were very popular at that point in time.
06:38 And every time people will say,
06:39 no, no, we are going to wait for 8%,
06:41 we are going to wait for 7.75%.
06:44 One year down the line,
06:45 we know that seven and a half percent
06:47 was the peak of 10 year in the current cycle.
06:50 But then it was very difficult to take advantage of that
06:54 because it is very difficult for us
06:57 to then be able to convince people.
06:59 So, there are multiple dimensions of the entire process
07:03 and the ability to predict if one can,
07:07 the peak of the interest rate
07:08 is just one part.
07:09 We believe that if somebody's following
07:12 an investment process for an investor,
07:15 that is important.
07:18 Being able to predict the peak
07:19 is just one trading call, which can be right.
07:22 So, I don't think that is the key to success.
07:25 Key to success is a systematic approach,
07:29 a disciplined approach to the market,
07:32 and then top it up with a good risk management system.
07:36 - Got it. A few aspects will probably help investors
07:40 make the right judgment call as things stand.
07:43 We briefly talked about the Fed,
07:45 but just to round off that conversation, Mahindra,
07:48 you have a few commentators that are saying
07:51 that with inflation not having come off
07:55 as substantially as it should have,
07:58 and we saw the latest reading on the PCE,
08:01 and that still continues to be a little elevated.
08:05 It is moderating, no doubt about that,
08:07 but it hasn't gone to the extent
08:08 that the Fed probably would want it to.
08:11 And on the other hand, you see the resilience
08:13 in the economy from the jobs numbers
08:15 and all of the other high-frequency indicators in the US.
08:19 Some people are saying, what is the need
08:21 and what is the urge to cut too quickly?
08:24 And so, would you say that in this current environment,
08:28 one of the risks on the global end
08:30 is that the Fed does not move at all,
08:34 even in 2024, instead of two or three,
08:39 it might just cut once?
08:40 - I think that's a fair argument,
08:43 but as I said, look, there is no way
08:46 that the Fed target of 2% on inflation
08:48 is achieved in the current year.
08:49 I don't see that happening, honestly.
08:51 But then you have to look at one environment.
08:55 The inflation has fallen from 9% to 3%,
08:58 and the interest rates have gone up
08:59 from zero to 5.5%, right?
09:02 So today at 5.5%, Fed rate is almost 2%,
09:06 2.5% into positive real rates.
09:09 That is something which an economy,
09:11 a mature economy like US with so much of debt
09:14 is hardly going to be able to tolerate.
09:15 So, by not cutting rates,
09:18 is the Fed going to cause incremental damage to the economy,
09:22 or is it going to help the economy
09:24 maintain the current momentum
09:25 is one factor to be considered.
09:28 Now, let's also understand the fact
09:31 that when we're talking about Fed cutting rates,
09:33 we're talking of three rate cuts,
09:35 so you're saying maybe possible one rate cut.
09:37 So, all we are saying is the beginning of the rate cut cycle
09:41 to bring it back to a more neutral level.
09:44 So, as I said earlier in my comments
09:47 that the last 100 basis points of the rate hike
09:51 that we did in the last leg of the cycle was very aggressive
09:55 and from those times,
09:56 the inflation has fallen very meaningfully.
09:58 So, if the inflation is not going to go back to 2%,
10:02 it's not going to go back to 9% also.
10:05 Therefore, at 5.5%,
10:07 I think it's a low-hanging fruit for Fed to cut rates.
10:10 Now, we don't know whether they will cut or not.
10:12 Their guidance right now is clearly
10:14 for a rate cut in second half of the year.
10:17 All we can say that, look, if they don't cut,
10:20 then maybe they will possibly push the economy
10:23 to a slower trajectory than it would otherwise have.
10:26 So, these are the things that we can have control on,
10:29 but whether Fed will cut or not, we don't know.
10:32 Whether Fed should cut, in my view, very clearly,
10:35 yes, some part of the rate hikes can be reversed.
10:37 - So, the reason I've been stressing so much about the Fed
10:41 is that I wanted your perspective on whether or not
10:44 the RBI can move in isolation,
10:48 ignoring what the Fed is doing.
10:50 And of course, you've had the Reserve Bank of India governor
10:54 on multiple occasions.
10:55 He will probably reiterate this on Friday,
10:58 that the RBI and the Monetary Policy Committee
11:00 of the Reserve Bank of India does not make its decisions
11:05 based on what another central bank is doing,
11:07 but can it cut when the Fed has not cut?
11:11 - I think this needs to be looked at in two parts.
11:16 So, I think when the governor says
11:18 that our monetary policy is largely focused
11:21 on domestic factors and we don't cut our hike rates
11:24 because the other central banks are doing,
11:26 I think that's absolutely the correct situation.
11:29 And I think our, you know, it's very interesting.
11:32 Today, RBI has completed 90 years
11:34 and there was a big celebration.
11:35 And I think the way the RBI has conducted
11:39 the monetary policy, especially since the COVID time,
11:43 it has been an incredible, positive experience.
11:46 And therefore, RBI is today recognized
11:48 as one of the best central banks in the world.
11:51 But then, keeping that aside,
11:53 the domestic policy is not going to have a rate cut
11:57 because Fed is cutting rates.
11:58 But to the extent that if the Fed cuts rates
12:02 or if the Fed hikes rates,
12:04 it has impact on the global environment.
12:06 It has, therefore, the cascading impact
12:08 on the domestic economy.
12:10 There will be some impact.
12:12 And Fed is the mother market
12:15 for the money markets across the world.
12:17 When it's famous saying that when Fed gets crew cold,
12:22 the rest of the world sneezes.
12:23 So you cannot isolate ourselves completely
12:27 and say, "Look, I don't care what the Fed does
12:29 or doesn't do."
12:31 We care what Fed does,
12:32 but then we have our independent assessment
12:35 of domestic factors also.
12:36 And let me give you one quick example,
12:39 if you permit me a second.
12:40 In 2022, when RBI started hiking rates,
12:46 it coincided with Fed's rate hike cycle
12:50 because that's what the domestic requirement also was
12:53 that when the Fed has started rising rates,
12:56 it will have impact on the global liquidity,
12:58 global cost of capital,
13:00 and therefore it will have impact on domestic factors.
13:02 And therefore, we also started hiking rates.
13:05 And you can say that, "Look, RBI started hiking rates
13:07 because Fed has started hiking rates."
13:09 But look at February 23.
13:11 From February 23 to February 24,
13:14 RBI has been on a pause,
13:16 whereas the Fed has hiked rates four times
13:19 by a cumulative of 100 basis points in the last 12 months.
13:22 So in the last 12 months,
13:24 RBI reached its destination quickly.
13:28 And once it reached 6.5%, it assessed that,
13:31 "Look, now we don't need to hike rates
13:32 because our inflation is largely better, etc."
13:36 But for the Fed, the inflation continues to fluctuate.
13:39 So RBI in the current cycle itself has shown
13:42 that it is more focused on the domestic factors,
13:46 but it also considers the global factors
13:50 which can have domestic implications.
13:52 So we hike rates alongside Fed.
13:54 - So the follow-up, Mahendra, to that question is that
13:58 now that we've established it cannot move in isolation,
14:02 it is focused on domestic factors,
14:04 but we've looked at core inflation
14:07 and the print of core inflation over the last few months,
14:11 and we've seen it trending far below
14:13 what we've seen over the course of the last several months.
14:16 And the problem really in the headline number
14:19 seems to be food inflation,
14:20 which to a large extent one would argue is supply-side driven.
14:25 And so from that perspective,
14:26 are we heading into a scenario
14:28 where that weakness in core inflation
14:32 will translate into a slowdown in growth?
14:35 And so therefore, is the RBI required
14:38 or will RBI soon be required to act?
14:41 And therefore, can we see a change in the bond yields?
14:44 We're already seeing it at 7.06,
14:46 whereas as you pointed out not too long back,
14:49 it was at 7.5.
14:50 - I think overall macro assessment is very clear
14:55 that the next move of the Reserve Bank
14:57 will have to be a rate cut.
14:59 Now, we know that the food inflation is a challenge.
15:03 It's very volatile, but then it's real.
15:05 And therefore, at different points,
15:07 the food inflation can have different impact.
15:10 Sometimes the central banks ignore it,
15:13 considering it as highly volatile
15:16 and not structural in nature.
15:19 Other times, when there is a risk
15:20 of the food prices getting generalized,
15:23 then central banks might want to consider
15:27 the impact of that into the broader inflation index.
15:30 At this point, we are looking at the core inflation
15:34 easing significantly, and it is well below 4% now,
15:38 but then you also need to understand
15:40 that the core inflation has remained very sticky
15:43 for better part of the last three years.
15:46 So in the last three years,
15:47 when the core inflation was at above 6%,
15:50 our rates were not anywhere close to 7, 7.5%.
15:54 For better part of that time,
15:56 the rates were maybe more like 4.5%, 5%, then 6%.
16:01 So there is a little bit of lag or two counts.
16:05 One is that the average inflation in the last four years
16:08 and the interest rates in the last four years
16:12 are still balancing out,
16:13 something of the sort that is also happening in US,
16:16 which is why the Fed is being a little more patient
16:19 with the cutting of the rates.
16:22 And the second part is that there is a lag effect
16:25 with which the core inflation is easing.
16:28 It's historically known
16:29 that if the core inflation remains very high
16:32 and the headline inflation is trending down,
16:36 then over a period of time,
16:37 the core inflation will start to sink
16:41 with the headline inflation.
16:43 So these are some of the arithmetics of the inflation.
16:47 So therefore--
16:47 So just 10 seconds more.
16:50 Yeah.
16:50 Therefore, I think the clear direction in my view
16:53 for average to cut rates,
16:55 it's been half of the year,
16:57 but you know, the margin for which is very shallow.
17:01 Got it.
17:03 The last point,
17:04 and knowing that we're likely to see significant inflows
17:07 because of the inclusion of India
17:09 and a couple of bond indexes as well,
17:12 the last point is how do you see the yield curve developing?
17:15 We're already seeing on the longer end
17:18 the yields coming off.
17:19 And so to that extent,
17:20 I would think that there is a flattening
17:22 that has already taken place.
17:24 How do you see the yield curve progressing
17:27 and what, according to you,
17:28 should be the strategy that investors should adopt
17:30 in this given scenario?
17:32 So as you rightly said,
17:35 that the market is already expecting rates
17:38 and therefore to some extent
17:39 that is inflated in the flat yield curve.
17:42 So the yield curve is flat at the longer end
17:44 because of the expectations of the rate cut
17:47 and the yield curve is very flat at the shorter end
17:49 because of the tight liquidity conditions
17:52 and the scramble for deposits by the banks.
17:55 And now, in the last one year,
17:59 the US inflation has come down
18:00 and their interest rates are still high.
18:03 So the inflation has fallen from nine to three,
18:06 that year the print rate has gone from zero to five
18:10 and half in the US.
18:11 In India, the interest rates have come to,
18:16 I mean, the report has come to six and a half percent,
18:18 but inflation has largely remained unchanged
18:20 at around five to five and a half percent
18:22 in the last three years.
18:24 Therefore, the scope for the Reserve Bank to cut rates
18:28 in my view is rather shallow
18:29 because the differential between the US
18:32 and the India key policy rates
18:35 is just about 100 basis points right now.
18:37 And the inflation equation is against India
18:39 where our inflation is five and a half percent,
18:42 US inflation is at three and a half percent.
18:43 So I believe that the rate cut cycle
18:46 that the Reserve Bank may have will be very shallow.
18:51 And therefore, the impact at the longer end
18:54 will be in the first leg of the rate cut cycle.
18:56 So first rate cut or the background
18:59 or preamble to that will be driven by the easing of the rates
19:04 at the longer end, some part of that we are seeing.
19:08 At the same time, when the RBI turns accommodative
19:10 and the new year with the government spending,
19:13 the liquidity in the system will improve.
19:15 And therefore, the focus will then shift
19:17 to the three and five year of the segment of the LCA.
19:20 Therefore, I believe that after the first leg
19:22 of strong rally in the 10 year, 15 year segment,
19:25 gradually the LCA will become to steepen
19:28 from the bullish side, which means the three to five year
19:30 in the one year segment will come down.
19:33 Therefore, the curve will become a regular,
19:36 positively sloped ill curve in six months time.
19:40 - Okay, all right.
19:41 Thank you so much Mahendra for joining in
19:43 and having a conversation that we don't have enough,
19:46 I think on our programs.
19:48 Thank you so much for taking the time.
19:50 - Thank you so much for inviting me, thank you.
19:52 - My pleasure.
19:53 We have to slip into a very quick break,
19:55 but on the other side, we'll talk about
19:56 what you should do with this information.
19:58 How should you plan your fixed income strategy?
20:00 Do stay tuned.
20:01 (upbeat music)
20:04 (upbeat music)
20:06 (upbeat music)
20:09 (upbeat music)
20:11 Welcome back.
20:12 You're watching a special show that helps you understand
20:16 fixed income as things stand right now,
20:18 and what your strategy should be.
20:20 Now, we've discussed what will likely happen
20:23 on the interest rates in 2024.
20:25 And my previous guest is of the opinion
20:28 that we're likely to see interest rate cuts
20:30 by central banks in the second half of 2024.
20:33 With that information,
20:35 how should you change your fixed income strategy, if at all?
20:39 Amit Kukreja, founder of amitkukreja.com is joining in.
20:42 Amit, thanks so much as always for taking the time.
20:45 One, how should you plan your fixed income strategy
20:48 on an ongoing basis?
20:50 And two, as you would normally do in the equity markets
20:54 where you see certain segments or companies moving
20:57 and you make certain investments
20:59 with the interest rate cycle as things stand right now,
21:03 and your expectation of it moving,
21:05 do you also use that information
21:07 to make tactical investments in the fixed income market?
21:11 - Yeah.
21:13 So Alex, two, three parts to it.
21:15 One, if you are looking for a more stable cash flows,
21:20 then do not try to time the market
21:22 with respect to rising or falling interest rates.
21:25 Just get into fixed income products,
21:27 which are serving your purpose of regularity
21:30 in your cash flows.
21:31 But if you are looking for some opportunities
21:33 where you may want to have a little bit of alpha
21:37 with respect to being more aware
21:40 of how the interest rates are gonna go up or down,
21:43 then you can get into long duration bond debt funds
21:46 or even medium term debt funds
21:49 where we have the interest rate risk coming out
21:52 and playing in your flavor to give you alpha.
21:54 But generally I recommend the investors and the clients
21:58 that look for what exactly is your need
22:01 in the desire to have more alpha
22:05 in your fixed income portfolio
22:07 or from your debt funds portfolio,
22:09 do not go for a paper or a product
22:14 which has the credit risk involved in it
22:18 or which has a company risk involved in it.
22:21 So go for AAA rated papers
22:23 or a predominantly AAA rated paper product
22:27 and go for a little bit of trends
22:28 that you're seeing in the interest rates
22:30 and then get into the debt fund allocation as required.
22:33 - So would you say that like you do
22:36 in your equity portfolio
22:37 where you have a core and a satellite,
22:40 within your fixed income as well,
22:42 and first of all,
22:43 you have a longer term kind of a portfolio,
22:45 but your satellite is what you use for your tactical bets
22:49 or your tactical allocations
22:51 and what percentages can you look at here?
22:54 - Yeah, so thanks for bringing up
22:56 core and satellite structure.
22:58 So in core, something which is more regular
23:01 with respect to cash outflows,
23:03 then you can have a layer of satellite
23:04 where you can have a fixed income safer paper
23:08 and then you can have the tactical allocation.
23:10 So I would say if you are purely designing
23:12 a fixed income portfolio,
23:14 then at least 60% should be core,
23:16 the other 20 to 30% can be something
23:18 where you get the advantage of staying there
23:22 and deferring your taxes by accumulating the capital gains.
23:26 And lastly, 10 to 15% where you have the interest rate
23:29 playing a game of a generating kicker
23:32 for you in your fixed income portfolio.
23:33 - Okay, so that core,
23:35 what would you fill that core with?
23:38 Would you talk about, say, your government bond funds?
23:43 Would you talk about corporate bond funds?
23:45 Or would you also talk about target maturity funds?
23:48 - So I would go with target maturity funds
23:51 and I don't mind having some of the corporate bond funds
23:54 as well if they are really good company papers
23:57 in the mutual fund space
23:58 and they are a well-managed portfolio
24:01 which is done by the fund managers.
24:03 But overall, something which is safe,
24:07 as I say, in a fixed income portfolio,
24:08 go for SLR, S stands for safety of your corpus,
24:12 L stands for the liquidity
24:14 and R stands for the rate of return
24:16 and add to it the advantage of taxation
24:19 because in debt funds, you are deferring the taxes
24:21 until you are realizing the profits.
24:24 And you can also use the capital gains
24:26 to offset some of the capital losses
24:29 in the other financial products if you have incurred any.
24:32 So go for corporate bonds and target maturity funds
24:35 as the core.
24:36 - Fantastic.
24:37 I think that more or less covers the strategy
24:39 and as you pointed out,
24:40 don't necessarily jump the gun
24:43 based on what you might think happens with interest rate
24:46 and changes by the central banks
24:48 and have a more long-term strategy
24:51 and I think you've laid that out very well.
24:52 Thank you so much, Amit, for taking the time.
24:54 - Thank you, Alex.
24:55 - And that brings us to the end of this particular edition
24:58 or rather special broadcast on fixed income.
25:01 If you've got questions for us,
25:02 you can write to us on that number
25:04 that you see on your screen
25:05 and lots more coming up over the course of the day.
25:07 This is NDTV Profit.
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