Preserve capital and be prepared to invest in low return instrument

It is very clear that we are in a zone where valuations are stretched far beyond fundamental reality in most risk assets. "My advice would be to preserve capital and be prepared to invest in low return instrument. Abnormal liquidity distorts valuations and risk reward trade-offs. It is time to reduce risk in the portfolios," says Sandeep Bagla, Chief Executive Officer, TRUST Mutual Fund in an exclusive interview with Bizz Buzz

The US Fed has already given a roadmap towards reducing QE gradually and is likely to start raising rates in a few months. Asset prices should start cooling off as they try to build in scenarios of lower liquidity and higher US rates. The sentiment impact of US Fed moves will be negative for Indian bonds as well. Inflation is likely to remain elevated in the first quarter 0f 2022, and that could result in a weak quarter of bond performance as well

The belief that current inflation is transitory stems from fact that there is a large output gap in the economy. However, if inflation is cost push, there could be low growth in the economy accompanied by stubborn inflation. High inflation is and should be a grave concern for bond holders as it could reduce the purchasing power of their savings. It is a matter of time before investors demand their pound of flesh, and the interest rates start rising

Is high inflation a concern for bond market investors?

The belief that current inflation is transitory stems from fact that there is a large output gap in the economy. However, if inflation is cost push, there could be low growth in the economy accompanied by stubborn inflation. High inflation is and should be a grave concern for bond holders as it could reduce the purchasing power of their savings. It is a matter of time before investors demand their pound of flesh, and the interest rates start rising. There are times when central bankers try to pursue objective other than inflation management. Typically, it is to support growth and currently, most global central bankers are trying to support growth by easy liquidity and extraordinarily low rates. The danger is that the inflation rises and which it has in developed markets and as well as developing markets like India and if inflation doesn't come down soon and is stubborn then the central banker will have to raise rates much higher than what they would have to if they are proactive. So those higher rates can affect the economy in an adverse manner.

Kindly throw some light on US Fed meeting and its impact on bonds.

The US Fed has already given a roadmap towards reducing QE gradually and is likely to start raising rates in a few months. Asset prices should start cooling off as they try to build in scenarios of lower liquidity and higher US rates. The sentiment impact of US Fed moves will be negative for Indian bonds as well. Inflation is likely to remain elevated in the first quarter of 2022, and that could result in a weak quarter of bond performance as well. As data comes in we will have more information coming from the global central bankers and from our central bank RBI as well. In the latest RBI policy, RBI seem to be oblivious of the inflationary pressure and wanted to be supportive of the growth impulses while keeping macro fundamentals stable. The US data has been coming stronger which basically implies that there is possibility that US Fed might increase the amount of tapering and the rate hikes could come faster than what the market expects. As per recent research report, Morgan Stanley predicted that India will be included in global bond indices in early 2022 and this will lead to huge foreign inflows in the Indian onshore corporate bond market in the medium-to-long term.

What are your views on the same?

Morgan Stanley also expects Indian operative overnight rates to go up by 150 bps in 2022. It is difficult to envisage large inflows in a hostile interest rate environment. My understanding is that a few Government securities could be included in the global bond indices. There must be niggling issues, otherwise the inclusion would have taken place by now. It should lead to large sums of money being invested in Government bonds. However, the process may take longer than expected, and the many investors have been known to avoid buying bonds in countries where the real rates are low or negative. Do not expect by any change in corporate bond allocation on account of inclusion of select government bonds in indices.

Because of the Covid related slowdowns the requirements of Government borrowing has gone up quite a lot and most people are expecting that the same amount of borrowing will be conducted next year as this year. Now, in this situation it would be really helpful if the Government bond auctions could be partly taken up by the global investors and the tie up with the global bond indices in the first quarter of the next financial year.

In a strategic move, participation of individuals in the government securities (G-Sec) market is now formally opened up with the launch of '(RBI) Retail Direct', as a one-stop solution to facilitate investment in G-Secs by individual investors. Do you think the move can be a game changer?

There have always been expectations by the issuer that there is large latent demand for Government bonds in the Indian retail investors. The hypothesis will now be tested. Government bonds are risk free as RBI can print Rupees and pay the investors. However, they yield lower than corporate bonds or FDs. One advantage of Government securities is that one can match their investment horizon with the maturity of G-Secs, which can extend up to 40 years. Expecting the move to be a game changer would be a stretch, unless Government is prepared to make the interest tax free. Another advantage from these bonds could be loans that could be procured with government securities as collateral and the haircut on the collateral would be quite low as the Government bonds are deemed as risk free bonds.

How do you see the current volatile market and what is your advice to retail investors?

It is very clear that we are in a zone where valuations are stretched far beyond fundamental reality in most risk assets. My advice would be to preserve capital and be prepared to invest in low return instrument. Abnormal liquidity distorts valuations and risk reward trade-offs. It is time to reduce risk in the portfolios. One can invest the money in bond portfolios of lesser than three years maturities or into short term or floating rate funds where the capital will remain protected while the returns might be low but positive. In case of equities, since the market has run up quite a lot and these expectations that in the future Fed will be hiking rates and global liquidity will be in the decline, it is quite possible that the market will fall to a new normal which will be much lower than the current market levels.

RBI is likely to hike key policy rates next month. Your comment?

RBI should start broadening its target parameters to include inflation and start raising rates gradually but immediately. Politically, we could wait for a few more months, but normalising rates by increasing them seems to be a better economic choice.