The talk of an imminent rate hike is getting louder with each passing day. Shivani Bazaz of ETMutualFunds reached out to Lakshmi Iyer, CIO-Debt & Head-Products, Kotak Mahindra Asset Management Company, to find out what’s in store for debt mutual fund investors. “Fixed income offers plethora of strategies to suit various interest rate scenarios. Key is to identify them and marry them to suit your investment needs,” says Iyer.Edited interview.
The talk about a rate hike is getting louder with each passing day. How do you read the situation? You think we are getting into a tightening cycle?
World over bond markets are pricing in rate hike expectations already. In India too, aggressive rate hike are being priced in. we are already seeing liquidity normalizing phase currently. This could be followed by narrowing of the repo /reverse repo corridor by hiking reverse repo rate in the next couple of months, followed by change in monetary stance from accommodative to neutral. We expect repo rate hike sometime in mid CY 2022.
How long will it last? Typically softening or hardening of rates last at least a couple of years.
Interest rate cycles longevity is a function of the economic health. The post pandemic phase is likely to see strong rebound warranting the normalizing /tightening cycle to last atleast a couple of years
When do you see RBI hiking rates? How much do you see policy rates going to go up in the coming year?
The IRS market (interest rate swap) are pricing in over 100 bps of repo rate hike over next 1 year. We are of the view that the rate hike cycle maybe more gradual in nature.
What other RBI measures can keep the rates higher in the coming year?
India enjoys better real rates compared to most other countries. Apart from hiking benchmark rates, the RBI has other tools like OMO sales, CRR hike etc. while these are primarily liquidity management tools, they do impact the yield curve as well.
Should investors stick to short term funds? Which other debt funds can they choose?
Investors should try match their investment horizons closer to the duration of the fund. This allows more tolerance to volatility. The focus for fixed income investors is more likely to be on portfolio carry than capital gains. Hence low to moderate duration funds could be an option
Many people are betting on floating rate funds. A lot of people continue to bet on banking and PSU funds and corporate bond funds. How will these schemes perform in a rising rate environment?
Floating rate funds tend to invest predominantly in floating rate instruments. These act as a natural hedge when interest rates rise as there is coupon reset at periodic intervals. Hence such funds could be considered in such rate scenario. BankingPSU / Corp bond funds usually low to moderate duration with high grade portfolios as well. So they could wells suited given the need for yield carry
Should investors in long debt funds and gilt funds stick to their investments during the rate hike cycle to maximise their returns?
That may not be required. Fund houses are positioning such strategies to have combination of mid duration assets, floating rate instruments etc to manage the current rate scenario. Once there a reasonable sync in with the investment horizon to the portfolio duration, the need for active churn may at investor level may not be warranted
What is your advice to our readers in a rising interest rate environment?
Fixed income offers plethora of strategies to suit various interest rate scenarios. Key is to identify them and marry them to suit your investment needs. Once that is done, volatilities can be ignored as they act as a noise to asset allocation.