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Head Fixed Income & Structured Products,
ING Investment Management(INDIA).

Fund Manager speak

How are clients generally looking to find value in the credit markets at the moment?

High-grade corporate bonds offer good value in the credit markets today. The credit spreads for 1 yr AAA corporate bond is around 200 bps and for 5 yr AAA bond the spread is around 170 bps. Given this mutual fund products which have a higher exposure to corporate bonds like liquid funds, liquid plus funds, Fixed maturity plans, Short term bond funds and Income funds are good investment options for investors.

We are also seeing increasing interest of investors in 1-yr higher yielding FMPs, where the credit quality of papers is in the A-AA range. These offer 50-100 bps higher returns than similar maturity AAA FMPs, albeit with a slightly higher credit risk. ING Investment management has been a pioneer in this space and we feel that at these spreads, the risk-reward ratio is attractive.

Why should retail / institutional investors look at Fixed maturity plans as against Fixed deposits of banks?

Fixed maturity plans (FMP) as an investment option has gained significant momentum in the recent past, both for retail and institutional investors. FMPs are funds of a fixed maturity (typically 3 months to 3 years) wherein the assets invested in are corporate bonds with a maturity similar to the maturity of the plan. The advantages of such products are many. Since the investment horizon matches with the maturity of the assets, price risk is minimal. The credit risk is also low as investments are in high-grade instruments. The returns provided by these funds are also attractive compared to other investment options like fixed deposits.

For example 1 yr P1+ corporate bonds as I write this article is trading at yields of around 9.25-9.5%. Net of expenses the potential indicative portfolio yields of a 1 yr FMP would be around 9-9.25%. Post tax return assuming that the investor is in the growth option and assuming that the long term capital gains tax rate including surcharge is 11.33% the post tax returns would be around 8-8.25%. As against this the 1 yr fixed deposits rates offered by good nationalized banks is around 8.5-9%. Interest income for a high tax bracket investor is taxed at 34%. Hence the post tax return offered by a fixed deposit would be around 5.6-5.9%. Hence the post tax returns offered by FMPs is typically much higher that alternate investment options like FDs. Due to the above reasons investors today are finding value in fixed maturity plans.

How have the products performed so far to date?

FMPs have been giving attractive post tax returns to investors. Since these are opportunistic funds which are launched when the corporate bond levels are high they have by large outperformed other investment options for the investor at the time of investment.

Why are FMP products suited to the Indian market over the next 6 to 12 months?

Typically the second half of the financial year (September to March) sees tight liquidity conditions in bond markets owing to higher credit offtake during the busy season. In general corporate bond yields move up during this period and credit spreads become attractive. This presents opportunities for investors to invest in FMPs of various tenures to capture these attractive yields with a good amount of diversification and lock-on to attractive post tax returns. Hence we feel FMP products are well suited for investors over the next 6-12 months.

Where do you see the biggest opportunities for you in terms of the way the domestic market is developing?

The biggest opportunity lies in launching absolute return funds. Indian investors today typically are absolute return investors. So far we have not seen any launch due to the fact that we cannot make money in a rising interest rate market. There are also no tools to hedge credit risk or make money if you have a negative view on credit. Swaps are the only hedging tools today. We are just now seeing 'restricted' launch of single name CDS in the Indian market and a possible launch of interest rate futures and options next year. Shorting is also not allowed. All these constraints could possibly be removed in the next 6 months - 1yr. If that happens we could see launch of absolute return funds.

What most concerns you about the future of the market?

The pace of development of the debt/credit market is a significant concern. The Indian debt market is still underdeveloped not only in terms of new instruments but also poor liquidity. The only market where there is a reasonable amount of liquidity is the government securities / swap market. The credit market (corporate bonds, ABS, MBS etc.) is mostly illiquid except for the short end. My prescription for development of corporate bond markets is as follows :-

1. Relaxation of investments restrictions on investment pattern of the Insurance companies and Provident Funds
i. allow a higher exposure to private sector corporate bonds with a minimum investment grade rating
ii. allow exposure to asset backed securities and mortgaged back securities with AAA rating
iii. Allow the fund managers (of insurance companies / PFs) to decide on asset allocation.
2. Remove selling/trading restrictions of debt instruments invested by Provident Funds.
3. Allow corporate bonds as eligible securities for Repos.
4. Allow mutual funds to short in the government securities market for better price discovery.
Just making companies to list the corporate bonds and having a screen based trading system is not the answer for improving liquidity of corporate bonds.
5. Introduce interest rate futures and options ?this would help investors to not only hedge portfolios but also to enhance returns when interest rate cycle reverses upwards 6. Allow participation in ‘credit default swaps?for mutual funds ?this would help fund managers to hedge actively credit risk which would ultimately protect mutual fund investors.

  • Mr.K.Ramanathan,
  • Head fixed Income & Structured Products, ING Investment Management(INDIA).

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