Debt fund investors' aim should be capital protection: Sandeep Yadav

Senior executive of DSP Mutual Fund debt funds will continue giving good returns after tax changes

As yields are unlikely to go up significantly, it is prudent to buy bonds of longer duration and wait for rate cuts, says Sandeep Yadav, senior vice president, head - fixed income, DSP Mutual Fund (MF). Yadav spoke to Abhishek Kumar in an interview advising how investors can reduce their tax outgo after indexation benefits from debt MFs were removed.

Here are edited excerpts from the interview done over email.

Do you see improvement in fund performances to maintain an edge over other fixed-income options after the tax changes?

We will see more active management from fund houses in search for additional returns. However, it is not likely that fund managers will suddenly take big risks. Debt funds have given reasonable returns in the past and I don’t think the industry needs to make sudden drastic changes.

Will you be considering a higher credit risk?

The credit risk we approve is driven by our comfort on the underlying companies, rather than to boost returns. We intend to maintain the discipline of our credit boundaries. However, within this fund house credit boundary, each of our debt funds can decide a narrower credit boundary. This is driven by the investor profile. If we find that many of our investors in a specific fund are comfortable with a wider credit boundary, we may think of relaxing the boundary for that fund.

What would be your advice to investors in terms of debt allocation strategies?

Investors can look at hybrid asset allocation funds that have more than 35 per cent in equity. Most of the investors have a mix of debt and equity portfolios. These investors, rather than investing in such funds separately, can now look at hybrid funds that inherently optimise the tax outgo. For those who invest purely in debt, MFs will continue to provide better tax efficiency compared to most other alternatives – though much less effective than what it used to be.

How are your debt portfolios placed right now? Do you expect a pause in interest rates?

We have added duration risk and are invested in longer maturity papers. While it seems probable that rate cuts may occur later in the year, it is still not a surety. Rather, what we are more confident of is that the yields have a lesser chance of rising up. In such a scenario, we believe it is more prudent to buy bonds and wait for the yields to fall.

The view on debt funds is divided. While some are advising investors to stay at the shorter end of the curve, others say it's the right time to lock in returns in longer-duration funds. What is your take?

I believe that the shorter end of the curve may not be an ideal point in the curve. So, what is the optimal duration? Today, the yield curve is very flat—that means that there is not much difference in yield between a 5-year and a 40-year bond. This curve will steepen if there’s a rally. Thus, while the 40-year paper may have more duration, its yields may fall less than, say a 10-year paper. Moreover, the changes in insurance regulations and government market borrowing calendar may put more pressure on long term yields. Hence, the 5 year to 10 year bonds seem most lucrative. The longest duration papers may not rally too much, and the shortest duration papers may not provide higher returns.

The MF industry has highlighted that lower inflows in debt funds will have a negative impact on the bond market, especially on the liquidity side. Will it impact debt funds?

MFs usually have larger shares in the less than 5-year corporate bonds. Unless there are more regulation changes that incentivizes non MF participants to buy corporate bonds, the bond market will face headwinds. However, even if the yield spread between corporate bonds and g-secs widens, I do not think it will have a meaningful impact on debt fund performances in the long run. Any immediate impact should subsidise soon. With time the bonds held by MFs reduce in duration and any negative impact will be much lesser. Moreover, as the yields widen, the maturing bonds in these funds will be invested back at higher spreads.

What would you recommend investors: active or passive debt funds?

Active funds have shown in the past year that they can protect against any sharp negative market movement. I would prefer active funds as they offer protection during the bad phases. For debt investors, the primary aim should be capital protection.