Informist, Friday, Sep 6, 2024

--Bandhan AMC Choudhary: Use govt bonds to maximise duration
--Bandhan AMC Choudhary: 10-yr gilt attractively priced at 6.85-6.90%
--Bandhan AMC Choudhary:Structural, tactical view on gilts converging
--Bandhan AMC Choudhary:Mkt underestimating favourable demand in gilts
--CONTEXT: Bandhan AMC debt head Choudhary's remarks in interview
--Bandhan AMC Choudhary:Gilts to outperform spread assets for 3-4 yrs

By Aaryan Khanna and Sachi Pandey

NEW DELHI/MUMBAI - Government bonds are likely to outperform spread assets over the next three to four years, according to Suyash Choudhary, head – fixed income, of Bandhan Asset Management Co. The key focus of Choudhary's strategy for generating long-term returns is through government bonds.

"Given the way we see G-Sec versus state bond supply or G-Sec versus corporate bond supply, we think these spreads will expand much more over the next three, four years," Choudhary told Informist in an interview. "So our strategy is predominantly - fill your carry book through corporate bonds, which is up to three year largely speaking, where even the corporate bond spreads are maximum. And then use government securities to build your duration."

The demand-supply dynamics for government bonds remain highly favourable for the next four to five years, driven by a combination of factors including the rapid consolidation of the Centre's fiscal deficit and a strong pipeline of global institutional demand for Indian government bonds, Choudhary said.

"Our sense is, generally speaking, people are still underestimating how favourable the demand versus supply environment for government bonds is for the next four or five years," Choudhary, a market veteran for two decades, said. For 2024-25 (Apr-Mar), the Centre's borrowing aim was already 1 trln rupees lower than market expectations in the Interim Budget. The aim was further cut by 120 bln rupees to 14.01 trln rupees in the full Budget presented in July.

Already, the spread of the 10-year corporate bond over the 10-year gilt has widened to 40-50 basis points, up from 20-30 basis points at the start of this financial year. Similarly, the spreads for five- and three-year corporate bonds over government securities have increased to 60-75 basis points, compared to 40-50 basis points earlier in the fiscal. Choudhary attributed the underperformance to the pressure on banks' credit-to-deposit ratios. The CD ratio of banks has kept one-year bank certificates of deposit stubbornly high, which, in turn, has led to a negative slope in the corporate bond curve, he said.

"So banks are experiencing pressure on credit to deposit ratio...and the pressure on corporate bonds will start to come off as the (credit-deposit) ratio problem stabilises," he said.

For long-duration corporate bonds, Choudhary suggests caution, pointing out that the thin spreads at the longer end of the corporate bond curve make these investments less attractive, especially compared to government bonds. He anticipates a "bullish widening" of corporate bond spreads – yields on government debt will come down more than those on corporate bonds.

The fund head has put his money where his mouth is. In the Bandhan Corporate Bond Fund, Choudhary maintained a quarter of the allocation in government bonds as at the end of August. In the Bandhan Dynamic Bond Fund, he has put all his eggs in the 7.30%, 2053 bond's basket, with less than 1% left over for cash or other bond holdings.

"...whatever your view is, I think the first order of business has to be to maximise your duration consistent with your view. And in our very strong belief, as far as possible, choose government bonds for maximising duration," Choudhary said.

TACTICAL TRADING

The house view on bonds' dominance is because of a confluence of India's structural strength and a constructive rate view, with the world's economies moving into an easier monetary policy environment, according to the investment head. Bandhan AMC's call is for a 75-basis-point rate cut cycle in India, slightly sharper than the shallow 50 bps market consensus. These rate cuts may materialise between December and June, with the Monetary Policy Committee likely to let go of its "withdrawal of accommodation" stance at the upcoming policy review in October.

"In our very strong view, you know, one has to focus on the big picture today rather than fret too much about the evolving shape of the curve," Choudhary said. "Those shapes will matter when a bulk of the rally is already through...but right now we are just scratching the surface on this."

India's bonds are still attractive for foreign investors in spite of the central bank's actions against the ease of investing in some long-duration gilts, Choudhary said. The RBI had in July said that new issuances of 14-year and 30-year government bonds will no longer be eligible under the Fully Accessible Route, which has no limits for investment by foreign portfolio investors. Still, Choudhary prefers the erstwhile 30-year benchmark 7.30%, 2053 bond, which is in the fully accessible route, over the newly issued 7.09%, 2054 gilt.

The near-term trading range for the 10-year gilt yield would be dictated by how aggressive traders expect the US Federal Open Market Committee to be in cutting interest rates. The expectations of the first US rate cut being 50 basis points rose to 41% today, the most in a month, on the CME FedWatch, as recent labour market data in the US shows signs of weakness. Regardless of the US rate view, with most market participants expecting a rate cut in India in 2024-25 (Apr-Mar), the 10-year gilt yield at 6.85-6.90% had a lot of room to fall even in the near term.

"...if the broader question is whether gilts are fairly or cheaply valued or attractively valued, the answer is an emphatic yes!" Choudhary said. "In fact, everyone is bullish about the fiscal stance. Everyone is bullish about net demand versus supply. And yet with some modest rate cut expectations also baked in, you are still 40 basis points over the repo rate."

Moreover, with CPI inflation falling on year, bond yields have become even more attractive. India's 10-year gilt yield maintains nearly a 240-bps spread over forward forecast inflation for 2024-25 by RBI, along with the stable macroeconomic indicators that would attract investors, Choudhary said.

"On both ways, which is distance to repo rate and spread over the inflation forecast or real positive yield, we are very attractively priced," the money manager said.

STRUCTURAL SUPERIORITY

In notes over nearly the past year, Choudhary has consistently referred to the positive structural story for India's rates. He shed some more light on this thesis, through which he says that India's rates story has a long enough runway so as not to be exhausted only over the next six months.

The confidence in India's fiscal trajectory has undergone a sea change over the past year, as the Centre has brought down its fiscal deficit aim to 4.9% of GDP in the current fiscal from 9.3% of GDP in 2020-21, Choudhary said. Its adherence to a stated fiscal glide path after the COVID-19 pandemic brought additional confidence to investors, the fund manager said.

India's current account and inflation situation are also sound, and seem to be ready for problems that may come up in the next few years. This level of confidence in India's macroeconomic indicators has not been possible in the past for an investor, the fixed income head said.

"We used to be at 1% current account (deficit) either if growth was weak or commodities had collapsed," Choudhary said. "This is the first time it's happening when growth is fine and the commodity cycle, though weak, is not collapsing. And this is happening because of services trade surplus, and this seems sustainable." India's current account deficit narrowed to 0.7% of GDP in 2023-24 from 2% of GDP the previous fiscal.

Bandhan AMC's fixed income head was also all-praise for the RBI's action in the post-pandemic years, which has bolstered its credibility on inflation targeting, he said. The central bank was quick to normalise after the effects of COVID abated, and did not tighten monetary policy conditions to choke the economy, which exhibited world-beating growth in 2023-24. RBI Governor Shakikanta Das has been recognised by several international publications over the past two years as among the world's best central bankers.

Adding to this is a massive increase in foreign portfolio investment into gilts in particular, attracted by India's stable currency, strong macroeconomic indicators and the inclusion of fully accessible route gilts on global bond indices. Their holdings of government bonds could double over the next three to four years from the current 3%, Choudhary said.

"The bond index inclusion is just the nudge that is required to for you (as an FPI) to set up account here and participate in what is a brilliant macro story that is unlikely to change," Choudhary said.

Moreover, this comes at a time when the US fiscal policy is likely to lead to higher average inflation and a weaker dollar over the next decade. This would naturally bring investment into a country like India, which is likely to be shining on those indicators for many years to come, the fund manager said.

INVESTOR OUTREACH

Choudhary notes a shift in investor behaviour over the past two years, in part because of recent tax changes on debt mutual funds. In the Budget for 2023-24, the government said all capital gains from debt mutual funds would be taxed at the investor's slab rate, rather than imposing capital gains tax with indexation benefits. It rolled back some of these changes in the latest Budget in July.

The removal of tax benefits for debt mutual funds had led to a front-loading of fixed income allocations before the rules kicked in, dulling appetite for fixed income investment in 2023-24 at a time when interest rate expectations were constantly in flux. Additionally, the strong performance of risk assets have made fixed income returns less appealing, further dampening inflows into debt mutual funds, he said.

"I'm no expert on the risk asset side but the only comment I'll make there is that it (outsized returns) has distorted asset allocations," Choudhary said. "So 6-7% (returns) has no appeal because you have seen 15% or more (in equities)."

The benchmark Nifty 50 index rose nearly 30% in 2023-24. To expect such returns consistently would be unrealistic, the debt head said. However, these factors, combined with the higher taxation, have shifted investor focus away from long-term participation in fixed income and towards other asset classes, he said.

"All these variables have kind of contributed to do two things. First, the nature of participation especially for retail is not as long-term as it used to be. And second, overall flows to some extent would have been impacted in favour of other asset classes," Choudhary said. End

Edited by Vandana Hingorani

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