Short-term income funds should offer good risk-adjusted returns

At a time when investors are turning risk averse and equity markets have become volatile, debt schemes can offer good diversification
benefits, says Shriram Ramanathan, portfolio manager for fixed income, at Fidelity Mutual Fund. In an interview with Bijoy Sankar Saikia, Ramanathan says short-term income funds provide investors with a good opportunity to benefit from higher yields. Excerpts:

n Why is there this sudden rush among mutual fund houses to launch short-term income funds? How does Fidelity’s new scheme stand out from the rest?
We believe short-term bond yields are now at a more appropriate and attractive level and investors can take advantage of this. On a risk-adjusted basis, short-term income funds provide a good opportunity to benefit from the higher yields, keeping interest rate risks at an acceptably low level.
Fidelity Short Term Income Fund will invest in a fresh portfolio at the current high short-term yields and, thus, it will be devoid of any historical baggage of low-yielding securities.
This is likely to provide investors with a good starting point, which should enable the fund to deliver attractive risk-adjusted returns over the coming years. As we are reaching out to investors with a six-month to one-year time horizon for the fund, this will enable us to be appropriately invested in the portfolio and focus on delivering an attractive portfolio yield.

n There has been a concerted effort among fund houses to lure investors from bank savings into debt funds. How do debt funds stand out vis-à-vis bank deposits at a time when fixed deposit rates are rising?
Debt schemes offer good diversification benefits as long as prudent risk management policies are followed. At Fidelity, we have a strong in-house credit evaluation team which helps deliver value through credit selection — both in terms of spotting upgrade candidates and in staying away from deteriorating credits. The ability to adopt different fund strategies and optimise fund returns through different stages of an interest rate cycle can help offer competitive post-tax risk-adjusted returns.

n SIPs or systematic investment plans have really caught up with equity fund investors? Do you have a similar scheme with debt products too? If yes, how does it benefit investors?
SIPs enable disciplined investing and help investors benefit from both up and down phases of the equity market — when the market goes down; the investor accumulates more units and when the market is up, the value of investments increases. We have been promoting SIPs in our funds in a big way ever since we started our asset management business in India. In fact, we were the first fund house to offer SIPs in a new fund offer in March 2005, when we launched our maiden fund. All our open-ended fixed income schemes in their retail plans, including the recently launched Fidelity Short Term Income Fund, offer SIP, STP (systematic transfer plan) and SWP (systematic withdrawal plan).

n The rate of inflation is falling and RBI has indicated that it will pause in hiking interest rates. What’s your outlook on interest rates for the next six months?
Amid tight liquidity conditions, rate hikes by RBI have pushed up interest rates across the yield curve, but the short-term rates have moved up more sharply — to the extent of 2.5 per cent to 4.5 per cent across instruments and tenures.
The liquidity situation remains tight and it is expected to remain so for some time. However, given RBI’s policy intent, it becomes clear that the central bank recognises the need for adequate liquidity to fund growth. Hence, we are likely to see some liquidity easing measures from RBI in the coming months and this may lead to a gradual softening of short-term rates over the medium term. Long-end rates are already at the higher end of the range as they have priced in liquidity tightening and any further upward movement looks limited.

n We hear about a section of investors turning risk-averse and selling off equities to take shelter in safer instruments. If so, where do the downside risks lie?
At Fidelity, we have always emphasised the long-term disciplined approach when it comes to investing to meet one’s financial goals. However, at a time when investors have turned risk averse with hardening interest rates and increasing equity market volatility, we believe short-term income funds can earn them attractive returns at an acceptably low risk level. Commodity-driven inflation risks on the back of further quantitative easing in developed markets and a stronger-than-expected capex cycle in the second half of next year leading to overheating of the economy are the key downside risks to watch out for from a fixed income market perspective. At the same time, we do not expect a significant upside pressure on yields from the present elevated levels, and so, the downside risk to performance looks limited.

n What investment mix should an investor go in for at this point of time considering the short-term interest rate outlook, concerns over the domestic currency, uncertainties in the equity market and the outlook for the broader domestic economy as well as global economy?
An individual’s asset allocation plan is dependent on his personal financial circumstances and financial goals. Having said that, we believe for the fixed income asset allocation, a combination of short-term income fund exposure with some allocation to long-duration gilt funds should prove rewarding over the medium term.

n How do you look at the bond market? Where are the yields heading?
Rate hikes by RBI amid tight liquidity conditions have pushed up rates across the yield curve. We believe a lot of negatives are already priced into the market at this stage and further upside pressures to yields look limited.