MUMBAI: R Sivakumar, Head – Fixed Income, Axis Mutual Fund, speaks to Neil Borate on possible interest rate hikes and the outlook on credit in 2021.

Interest rate hikes seem to be the largest fear of equity and debt markets for 2021. What is your view on the probability of such hikes happening?

The Reserve Bank of India (RBI) has been following an extraordinary stance on monetary policy with low rates and significantly excess liquidity. Data suggest that the worst of the economic impact of lockdown is behind us and we are now back in growth phase. As inflation remains above RBI’s 4% target, we believe there is little rationale for the current stance to continue for long. RBI will begin the process of normalization of rates and liquidity in the coming quarters.

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At the short end, liquid and overnight fund yields have lagged short duration, corporate bond and similar categories in 2020. Will this gap be filled?

Money market rates have remained very low thanks to the excess liquidity in the banking system. Even one-year treasury bill yields are close to the reverse repo rate which is the theoretical lower bound of short term rates. Historically the RBI has preferred to act with neutral to slight deficit liquidity to keep rates close to the benchmark repo rate. As excess liquidity gets removed, money market rates will rise. Short-term bond rates should also rise – and indeed short-term rates have normally risen more than money market rates during rate hike phases. This time around though we expect the gap between money market and short term bond yields to reduce.

Does roll down maturity still make sense with low yields? Should investors be locking in such yields? If so, what duration is ideal for roll down maturity products?

Roll down maturity is designed to reduce interest rate risk as time passes. Thus in a rate rise environment these strategies are less exposed to interest rate increases. We see two options for investors looking at roll down strategies. One is long tenor bonds which have significant spread over short bonds and thus are relatively insulated from rate hike fears. The second is very short term – say, between 1 to 2 years – which can benefit from reinvestment. In this case maturity proceeds can be reinvested at higher yields as rates go up.

Is the corporate bond market ready for low cost debt ETFs?

In India, we have seen specialized bond ETFs which offer roll down strategies focussed on very specific segments of the market, chiefly public sector AAA bonds. Globally we have seen bond ETFs span a larger range of issuers across ratings, which creates liquidity in these markets. This allows retail investors to participate in these markets which are otherwise difficult to access. The key building blocks for this are having a wide range of issuers listed and indices that reflect the diversity. Over time we can expect bond ETFs to become more relevant in our market.

What is your outlook for the credit space?

I think that following various RBI actions, the credit space has settled down in India. In fact there is an opportunity for investors in the AA space. In 2020 categories like corporate bond funds and banking and PSU debt funds were favoured by investors. But their yields have fallen (for example 2-3 yr PSU bond yields from around 8.5% to 4.5%). So now investors should look at both moving up the duration curve to an 8-10 year horizon for a small part of their portfolio and allocating another small part to categories like short duration which can invest in AA rated debt also. But be very careful of the sector and nature of the issuer. For instance an NBFC may have a AA rating but may be lending to A or lower rated borrowers.

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