Debt funds will continue to do good in next 2-3 years: Akhil Mittal, Tata MF

In a chat with ET Now, Mythili Bhusnurmath, Consulting Editor and Akhil Mittal, Senior Fund Manager, Tata Mutual Fund, discuss the macro cues including Fed rate hike, possibilities of RBI rate cuts and flow of FII funds. Edited excerpts

ET Now: The Morgan Stanley report besides calling India a defensive story also said a 50 bps more rate cut is expected over the course of FY17. How does that tie in if the strategy in the US is to hike rates and we are talking about a possible rate hike in June itself?

Mythili Bhusnurmath: If at all the Fed does hike rates, the scope for India cutting rates is very limited. So that is where I would disagree with the Morgan Stanley report. Where I would agree is that the Morgan Stanley report merely echoes what many people have been saying in the past that India’s performance particularly relative to its peers is better. In fact, it is a slightly more diplomatic way of saying that it is a low beta option as compared to other emerging markets.

But that is primarily because the other emerging markets, particularly the other BRICS, Brazil as well as Russia, are really struggling, South Africa is not in a much better place. In China, the growth has slipped as compared to earlier but they are still doing fairly well. So the fact is that India does look relatively better off as compared to its peers.

Coming back to the Morgan Stanley stance on a 50 bps cut, I am not so sure. Perhaps, a 25 bps cut is possible but that again depends on what the Fed does because if the Fed does hike rates then we also have FCNR redemptions coming up. So if you have an FCNR redemption and you have the Fed hiking rate, the scope for the Reserve Bank of India to cut rates is very very limited. That's where I would disagree with the MS Report but broadly I would agree that this is what everybody has been saying that we do look better relative to our competitors.

ET Now: Do you second that view as well it will be very hard for the RBI to cut rates if indeed that rate hike in the US becomes a reality come June?

Akhil Mittal: Yes, I agree with Mythili I mean a 50 bps rate cut it is a very tall call to make. A 25 bps rate cut is more suitable and more probable currently given the scenario of inflation on the Indian front. Remember Q4 in the last financial year our average inflation was almost 50 bps below RBI’s target so that gives some room. At the same time we are talking about a Fed rate hike so probably a 25 bps rate cut by RBI towards mid of the year assuming average normal monsoon could be a reality but 50 bps for now is a tall call.

Mythili Bhusnurmath: The Morgan Stanley Report also talks about corporate balance sheets improving and while we have seen fourth quarter results much better than in the previous quarters. Do you see any clear sign of that improvement being sustained? Is the kind of over leverage that we saw in the past history and in corporate balance sheets genuinely improving?

Akhil Mittal: It is a selective kind of change in balance sheet structure. You cannot generalise. The improvement for some companies and some sectors the balance sheets have improved but if you talk about the highly leverage entities who are still facing a tough economic cycle. I do not see any recovery in their balance sheets as of now so it is selective across sector specific to companies but yes broadly the companies who are not impacted by the downturn in economic cycle yes their balance sheets are improving, their profitability is increasing slightly.

Mythili Bhusnurmath: The mutual fund industry had an amazing run in the last two years because retail investors have returned to investing in mutual funds in a way that they had not in the past. But one large institutional investor who was not enthused at all by investing in the equity market is the EPFO. They say their experience with investing in the stock market has been very dismal. Of course, they have taken a year which is not a very correct assessment for yield from mutual funds. But what would you say -- do you think mutual funds are losing out an opportunity and they could sell this to the EPFO? The same kind of argument that you make for retail investors could be made to the EPFO saying why do not you invest in mutual funds because that would be a huge increase in the AUMs for mutual funds. So should mutual funds think in terms of attracting the EPFO money like that?

Akhil Mittal: There are talks. There are talks going on with EPFOs, with pension funds, with provident funds for investing in mutual funds. See the good side is – mutual funds do offer an array of products within the equity space which you can choose. So you could choose index funds. You could choose diversified funds. So you have a wide variety of choices available in front of you. I still believe that going ahead, you will have larger institutional investors like EPFO, other pension and provident funds coming into the equity market. So the change will not happen very soon. It will be slow and gradual but eventually lots of institutional money will come to mutual funds.

Mythili Bhusnurmath: If you speak of mutual fund industry, the last year has been pretty good for the debt funds rather than for equity funds. Is that story over and are debt funds unlikely to give the kind of returns they gave in the past? Also does the future lie with equity funds rather than debt funds?

Akhil Mittal: Equity and debt are two totally different asset classes. Talking purely on the debt side, last one year was a good year for debt. We had sharp rate cut by RBI which did translate into gains on the fixed income side. Going ahead, the issue is you will have lower quantum of rate cuts. So the quantum of rate cuts will be less but the good side is that the clarity on the monetary policy stance is still there in the system. So we are not talking about rate hikes or anything. We are probably looking at a lower quantum of rate cuts and a longish pause after that.

Given the low inflationary scenario and the low repo rate, the debt market still offers a decent risk adjusted return proposition over the next couple of years. Once you reach the terminal end of the easing cycle, that is when you might see risk premiums increasing on the duration and that is when you might need to relook at the aggressive duration strategy. But for now, as long as you are still not reached that situation where all the capital gains are over, debt funds do offer a decent risk return proposition.

Mythili Bhusnurmath: As far as debt funds are concerned, is it the yield that is going to be most immediately impacted and hence the kind of returns or are they going to be impacted more by the Fed rate hike because if the Fed hikes rates, you could see a return to safe havens. The inflows may come down sharply. So will people continue to invest into debt funds thinking the debt story is not over or will we find a large outflow particularly from FIIs?

Akhil Mittal: A little of both. A sharper or earlier than expected rate hike by Fed will force some outflow from the debt markets. At the same time, a probable or a high probability of cut in interest rates by RBI eventually translating into yields is also a reality. So what is happening is ever since RBI’s change in stance on the liquidity side from minus one per cent NDTL to neutral zone, one thing which is surely going to happen is the lower end of the curve keeps percolating down towards the repo rate. So as long as you are looking at a two-year, three-year scenario, you do not have too much risk as your repo rate is low and liquidity is sufficient. So the safety with regards to capital over there is much higher.

Short-term volatility will be defined by Fed moves and on a longer term, on a one-year, two-year horizon, it will be defined by the rate cuts or the monetary policy stance locally.

Mythili Bhusnurmath: But has the Reserve Bank of India delivered on its promise of neutral liquidity stance because I see they are still pumping in liquidity. So the situation still seems to be one of fairly substantial deficits. So how far has the Reserve Bank moved to deliver on that promise of a neutral liquidity stance?

Akhil Mittal: They have taken time till September to come to neutral liquidity zone. Yes, you are correct the deficit is still large. I think the growth in currency in circulation can be attributed towards that but the fact that Reserve Bank of India is doing OMO purchases continuously mean they are serious about bringing liquidity into a neutral zone and they are working consistently at it.

So probably by September-October, they would get close to the zone. Yes, FCNR B redemptions is probably one of the things to worry as to how RBI is going to maintain liquidity if a large outflow takes place.That is a big question mark. But leaving that aside, systematically RBI is working towards improving liquidity.

Mythili Bhusnurmath: Coming back to the mutual fund industry, Sebi is reportedly considering easing the restrictions on temporary restrictions that mutual funds apply in case there is a sharp fall in the NAVs. What is your view on it? Are you on the side of the mutual fund industry which obviously would like to retain the right to impose those restrictions or are you on the side of the retail investors who feel it is very unfair because when things are not going the way the mutual fund industry wants it to go, then suddenly these restrictions are imposed and retail investors cannot pull their money out as freely as they could before. Would Sebi be on the right track in easing the restrictions or do you think restrictions should remain and mutual fund managers should not be allowed to impose those restrictions?

Akhil Mittal: I mean it is a give-take both sides. It depends on the situation. In the past, the restrictions have helped in a longer term. So in a shorter span of time, you might see that these restrictions are causing or probably would have caused harm to investors but having those restrictions in place over a period of time has helped both investors and mutual funds. So you have a case on both sides but the only difference is how you look at it, whether you look at it in an immediate short term or you look at it at a longer term basis. That is the view one has to take over there.

Mythili Bhusnurmath: You are being very guarded in your response over there. Let me see if you are equally guarded in your response to the next question. Sebi has been talking about the need for rationalisation of mutual fund schemes. You have so many schemes which are virtually identical and despite that I find that mutual funds have again filed over 30 NFO applications. Why does the mutual fund industry keeps wanting to find finer and finer differences between the various schemes and this basically ends up in just confusing the retail investors and does not really add to the industry’s overall perspective or to its credibility?

Akhil Mittal: Sebi is now pretty strict on that side. Sebi wants to reduce these minute different schemes which exist in the system. As far as mutual funds are concerned, or filing of new fund offering with SEBI is concerned, it is very clear it has to be totally unique and not even close to something which is already there in the product offering. As far as existing schemes is concerned, Sebi taking a close look at all these schemes with similar features. In case there are high levels of similarity, Sebi is telling mutual funds to have a relook at their product offering. I do see lots of scheme mergers or lots of scheme winding ups happening on that front. As far as new offering is concerned, Sebi is clear. They are going to approve only if there is a particular gap or a particular niche for the product offerings filed. If it is closer to or if it has any resemblance to one of the existing products, Sebi is not going to give approval.