Q:  What is your investment philosophy?

A : We are investors in money market funds where people invest and demand money at a short notice. So in our thinking, trading liquidity of securities we invest in, is paramount to us. We also believe that return of principal is more important than the return on principal. Credit risk is what we are not prepared to take but we believe our investment strategy allows us to benefit from our views on interest rate.

I believe in top down investment approach and we start from the macro-economic environment down to the individual security. It’s the same way in the case of corporate bond selection, first it is the industry then it is the company. In an emerging economy like India, the government plays a huge role in the overall economy and ignoring macro environment is not wise.

Q:  Why focusing on the macro environment is important?

A : In India, most of the businesses are focused on the domestic markets. If you are in a domestic-oriented business, you have to start from the top down approach of how my economy looks. For me the most important thing is how is the domestic economy doing? After then comes the company, the same way about the government debt.

Q:  Are there any other guiding principles that affect your decision process?

A : Liquidity in the underlying bond is the prime factor that I pay attention to. For me, the illiquidity premium can be very attractive but I will still pass the bond. I believe that a huge premium will continue to be attached to the liquidity. Most money market funds are required to fulfill the redemption request on the same day, so I am always focused on the liquidity or ability to buy or sell securities I own in a day.


Q:  What is your research process?

A : There are three sectors that we research. One is the government bond sector, the other is the government-supported bond sector and the third is the private sector bonds. The government bonds or public sector linked bonds is dominant and is the most liquid in bond market. Since inception, we have taken exposure only to government and government supported entities.

We’ll not buy anything that is nongovernment supported. In India, the budgetary allocations are very high for government supported institutions. We always look at wherever the budgetary supports are high as it is in the power sector. I will always own any government-owned power sector company but this might not be true for a private sector power company.

I believe that in the coming two to five years, the government’s balance sheet will be much larger and the private sector balance sheet will be smaller. That is the fundamental belief with which we start our research process and this is going to be the case around the world.

In India, for the past four years, the private sector was leading the capital investment and prepared to leverage the balance sheet. In the last six months of previous fiscal, the investment from the private sector slowed down considerably. It clearly sent a signal to the government that now you’ll have to take the mantle. When the government increases its balance sheet, it crowds out the private investment. When the government increases balance sheet the process takes several years and when it slows its investment it cannot bring down the balance sheet in a matter of a year, that process also takes several years.

To protect our fund from the loss of principal, I want to be with somebody who can print currency if they have to repay me. At least with that they can pay me back. In India, banks are also nationalized, so they are more than happy to give money to another government sponsored entity if there is a liquidity crunch that cannot be said of the private sector company.

In India, when the economy was growing at 9% rate, the private sector and foreign banks took the market share from public sector banks. They got the new deposits and loans on their books. Those are the same loans which might be non-performing now. Today, the public sector is taking market share from private sector and foreign banks. In India, we are not used to having nonperforming assets in mutual fund portfolios. In fact, we never had.

Our money market net asset value never drops below initial allotment value.

In the current economic and financial market environment where bonds in the private sector may become non-performing I’d prefer to stick with the public sector where that risk is minimal.

Q:  In government and government-supported industries, how many instruments do you have?

A : In India, you don’t have the big derivative market. It’s only the cash markets. So, you don’t have complex structures and all. It is only the straight bonds.

We can have 20 to 25 government or government supported bonds that are AAA rated. In that we can easily choose as many as we need. These good companies have been there for 30 years with healthy balance sheets.

Ultimately, market trading is all about perceptions. Higher trading means market has more confidence in that. In our funds we are allowed to have up to 15% in one particular issue in our portfolios.

Q:  Generally, how many names do you have in the fund?

A : In the money market or which is the most liquid fund, we have more than 100 holdings because 70 of them are bank deposits linked with maturities of less than a year. Whereas, if you go to higher end of the maturity curve between five or ten year bonds, there are only 20 to 25 public sector bonds available.

The individual allocation in the money market fund can be as high as 6% and as low as 0.5%. The 6% allocation will be in the bond that can be traded very easily.

Q:  How is the liquid fund different from liquid plus fund?

A : Liquid fund is the money market fund and liquid plus fund was designed to take advantage of tax arbitrages. People traded it like a liquid fund but it has a separate Net Asset Value.

In liquid fund you can put money today and your investment is valued at previous day NAV. If you put money today in liquid fund, it can get to work today itself. It can start earning from today. In liquid plus fund if you put your money today, it can start working from tomorrow. People put money in the liquid plus fund because of the tax arbitrage.

Q:  And what is that arbitrage?

A : Between 10% and 12% which may be revised in the next budget. On a day-to-day dividend distribution tax is 22% and in liquid plus it is 10%.

If you invest in liquid plus fund, you have a lower tax. Depending on the liquidity needs and your tax profile you choose your fund. The people who have a longer time horizon prefer liquid plus fund. For somebody who prefers quick access to his investment, liquidity is the most important thing, like capital market intermediaries they select liquid fund.

Q:  How does the income fund different from other liquidity funds?

A : The income fund is the bond fund that can have between zero and 40% in the government bonds, zero and 40% in corporate bonds and up to 20% is money market securities or cash. The fund can invest in public sector bonds, corporate bonds with 3 years to 10 years tenures. The fund also buys a certificate of deposit to meet its liquidity needs. In the fund we have ten to twelve bonds from public sector and from private sector each and the rest of the asset is in money market securities.

India has a relatively developed corporate bond market than the rest of Asia and there are more than one hundred issuers every year.

Q:  How advanced is the bond trading?

A : The bond trading is automated but the price discovery is still done through OTC. The price discovery is slow as it requires talking to several dealers. It is still a phone driven market and when deals are completed the trades are reported on the National Stock Exchange.

The Bombay Stock Exchange and the National Stock Exchange are planning to develop a platform in the next three months.

Q:  How do you choose what maturities to invest in?

A : The government borrowing needs have a large influence on the market. If government is going to borrow a huge amount of money, it will not leave space for private sector or public sector to borrow money, which forces us to focus on the short end of the yield curve. For the past four to five months we have been interested in only 5-year corporate bonds and not beyond. A 5-year corporate bond can be supported by the overnight interest rates but a 10-year corporate bond is purely a function of capital gain or capital loss. Therefore, 5-year bond is where we prefer to focus where the volatility is lower and that is where most opportunity is to make money.

It is a perfect combination of liquidity, volatility and the availability of the instruments. These are less volatile and they provide you good entry and good exit opportunities.

Q:  What is the gilt-edged fund?

A : In a gilt-edged fund, investments are done only in government securities. A liquid fund can invest in corporate debt, money market funds and Treasury bills. It is a combination of Treasury bills and corporate securities. In the gilt fund it is only Treasury bills and government or government enterprises linked securities. And the fund is suitable for those investors who are looking to avoid credit risk.

In the gilt fund the maturity of bonds is between 5 and 8 years. I believe government balance sheet is going to deteriorate in the coming months and years. The current bond yield curve is not steep enough for us to select bonds beyond eight years as we expect the government to raise more money to pay for the economic stimulus.

Q:  What is your outlook for interest rate?

A : Interest rates will rise. In the months between April and September, the corporate bond issuance is almost zero. India is a festival driven market and in the second half of the year, September to March, corporations are very active. In the months between April and September, the government is the only borrower. When the government is the only borrower, I don’t run too much of a risk for government crowding out the private sector borrowing. The same thing is not true for the second half of the fiscal year. But as issuance form the government and private sector heat up in the second half the yields are likely to rise as well. By September to December of this year, I believe that yield on 10-year government bond will rise to 8% from 6.5%.

India has always been a capital deficient economy because we spend a lot of tax receipts only on revenue expenditure and capital formation is very little in the government sector. For the past four years, the economy grew at a brisk pace and the government allowed the private sector to borrow and expand while the government sector demand for money was reduced.

From this year private sector borrowing has collapsed and replaced by the government demand as it has embarked on a huge economic stimulus and has almost doubled its borrowing.

As much as 22% of Indian government budget is spent in servicing the fiscal debt. And with the rising government borrowing, less money will be available for the private sector and that’s why I believe the interest rates will rise. The outlook for interest rate is same everywhere in the world. The key difference between developed nations and emerging markets like India is, while the debts of developed nations are only downgraded but emerging market debts are downgraded to speculative levels.

India always had a trade deficit problem which the rest of Asia did not have. The problem was marginalized when the economy was expanding at solid pace of 9% but the deficit has not gone away. Now the growth in the economy has declined and trade and budget deficit has persisted.

Q:  What are your risk controls?

A : We are very liquidity focused managers so our first priority is to invest only in the most liquid securities. This helps us in managing our risk. We also control our credit risk by exposing only to the government or government linked enterprises bonds and limit our private sector corporate bond to the highest quality.

For interest rate risk we stay near 5-year duration in our funds so that we can act and trade with speed if the rate outlook changes. We are looking to exploit market inefficiencies by active trading and we are not long term holders of what we buy. We are not averse to selling quickly to cut losses in what we have bought and limit our downside. In India you cannot hedge your interest risk as there are no interest rate futures.