In current milieu, invest in schemes with shorter duration: Manish Banthia

We believe the RBI will pause rates for a longer period after the rate hikes are over. This is a typical attribute of an economy in mid-cycle; a phase India is in currently, says Manish Banthia

With the Reserve Bank of India (RBI) having shifted its inflation target from 4 per cent to 6 per cent, yields of longer duration funds are not attractive yet, says Manish Banthia, deputy chief investment officer-fixed income, ICICI Prudential Mutual Fund (MF). In conversation with Abhishek Kumar, Banthia explains why dynamic bond funds, credit-risk funds, and target maturity funds (TMFs) should be preferred by investors at this point. Edited excerpts:

With inflation easing, do you expect the RBI to pause rate hikes?

We believe the RBI will hit pause after hiking rates by another 25 basis points. This expectation stems from the fact that the central bank is close to the neutral zone of interest rate. The RBI seems content with inflation hovering over 6 per cent unlike before when its monetary policy actions were focused on 4 per cent inflation. 

Given repo rate has more or less peaked, which debt fund category is most suitable for a three- to five-year investment?

In the current milieu, we prefer investments in schemes with a shorter duration.

From a three- to five-year perspective, we prefer dynamic bond and credit category offerings with high yield-to-maturity (YTM).

Is the market attractive across the yield curve? 

The one- to two-year section of the curve - which is the shorter end of the curve - is fairly priced and is most attractive from an investment perspective.

The long end of the curve is flat and term premiums are very low.

With the RBI inflation focus shifting from 4 per cent to 6 per cent, the 10-year government security would be attractive only at an 8 per cent yield or above.

Also, with average inflation of 6 per cent, we don’t suppose rates are restrictive enough to trigger an economic slowdown. The economy is expected to continue to expand, with the overall monetary policy being supportive of growth. Therefore, adding duration to the portfolio may not be logical at this point.

Do you see investors returning to debt funds and inflows turning positive in non-cash schemes?

The period of low-interest rates is behind us. As the rate cycle is moving towards neutral, our view has turned very positive on a fixed income as an asset class.

Portfolio YTMs across categories look very attractive now. We expect a shift in investor appetite for debt funds.

On valuation parameters, fixed income appears attractively priced over other asset classes.

The YTMs of shorter horizon funds, such as money market funds, have been about 7 per cent for some time now. How long can it sustain?

The rates are expected to remain steady as the Indian economy has been doing relatively well and the growth expectation remains robust.
 

We believe the RBI will pause rates for a longer period after the rate hikes are over. This is a typical attribute of an economy in mid-cycle; a phase India is in currently. 

We saw a series of launches in the target maturity space this year. Why are fund houses so keen on having a bouquet of these funds?

TMFs are easy-to-understand products and investors have a fair view of the profile of risks and returns. Also, TMFs are better placed when compared to some of the traditional non-MF fixed-income options. If held for more than three years, investors benefit from indexation, which enhances the after-tax returns, especially for those in higher tax brackets. We particularly like the three- to five-year maturity plans in this space, against long maturity plans.

Credit-risk funds haven’t been at the top of their game for some time now - their performance only slightly better than top-quality debt funds. What has changed after the pandemic?

With economic growth picking up, so has the demand for credit. This will translate into higher YTMs for the ‘AA’ and ‘A’ category bonds. We see this as a future trend and therefore, are very optimistic about this category of funds. We believe this is a good time for retail investors to get into credit-risk funds.