The Last Lap

Posted On Monday, Jun 26, 2023

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Monetary policy in India is entering a new phase. Over the past two reviews (April and June) the RBI’s Monetary Policy Committee (MPC) decided to “pause” the rate hiking cycle.

The decision to pause was supported by confluence of factors such as:

  • falling growth and inflation globally
  • slowing pace of rate hikes in advanced economies
  • sharp deceleration in domestic inflation
  • high real interest rates
  • and, pending passthrough of past rate hikes into the economic activity and inflation.

The pause was termed as a ‘hawkish pause’. In simple terms, it means that although the RBI is comfortable not hiking rates anymore. But, by cautioning on future inflation, they are suggesting that aren’t likely to cut the rates anytime sooner.

“The Ideal Must Not Be Lowered “- Targeting 4% CPI inflation

When the RBI started its repo rate hiking cycle back in May 2022, they were hiking from a record low level of Repo rate at 4%. The first objective then was to ‘normalise’ the Repo rate to its long-term average of between 6.0% - 6.5%. The second objective was to try and bring inflation within the ‘tolerance’ band of 2% - 6%.

After a 250 basis points hike in the repo rate, interest rates are now near their long-term averages. The CPI inflation has also come down from an average of 6.7% in FY23 to below 5% in the last two months. It is expected to average near 5% in FY24.

Both these objectives are now met.

Chart – I: Repo rate are near long term averages; CPI inflation dropped below 6%

Repo rate are near long term averages; CPI inflation dropped below 6%

Source – Refinitiv, CMIE and Quantum Research, Data as of May 31, 2023.

The RBI did win the battle. But the war against inflation is not over yet.

The RBI governor in his policy statement acknowledged the same – “...being within the tolerance band is not enough. Our goal is to achieve the target of 4.0%, going forward.”

He aptly used the quote from Mahatma Gandhi - “The ideal must not be lowered” to suggest that monetary policy should move towards achieving the 4% inflation goal on a sustained basis.

Monetary Policy 2.0

The current inflation is not that far from the RBI’s 4% target. Also, with steep fall in commodity prices and improving supply chains, underlying inflationary pressures are much benign now compared to the last two years. However, as the Governor said - “It is always the last leg of the journey which is the toughest”.

In our opinion, the goal of getting to and sustaining at 4% inflation target cannot be achieved in a hurry. It will require patience. Changing the monetary policy will have limited utility in this part of the journey.

Although the rate hiking cycle was relatively short, it was very steep with 290 basis points of effective tightening (+250 bps repo rate + 40 bps SDF introduction over the then reverse repo rate of 3.35%) between April 2022 and February 2023. Full impact of these rate hikes is yet to be seen.

Thus, the RBI may stay put and wait for the disinflationary forces of falling commodity prices and elevated real interest rates to put further downward pressure on the CPI inflation. On the other hand, hiking rates too much now can hamper the nascent consumption recovery and could disrupt the economic growth, which is why the pause was a correct decision.

In our view, current monetary policy setup is neither restrictive nor stimulative for growth.

All in all, we would not expect any rate hike or rate cut in the foreseeable future unless something materially changes in the growth inflation dynamics.

What does this mean for the Bond market?

No change in monetary policy should bring some form of stability in the bond markets.

From a medium-term perspective, declining inflation, peaked policy rates and comfortable external position are all strong backdrops supporting the bond market. However, the near-term outlook is clouded by uncertainty over the timing, quantity and distribution of rain fall amid forecasts of El-Nino conditions which causes lower rainfall.

Also, after the sharp drop in yields over the last three months, the valuation cushion in the long-term bonds is exhausted. The 10-year Government bond yield has fallen sequentially from ~7.45% in March 2023 to around 7.05% now (on June 20, 2023).

The spread between the 10-year government bond and the repo rate has shrunk to 55 basis points. This is lowest level observed since 2017. The long-term average of this spread is over 100 basis points. Even during the 2019-2020 period when the repo rate was cut by 250 basis points, this spread was materially higher than current levels.

Chart – II: Spread between the 10year G-sec vs Repo Rate has fallen to 5 years low

Spread between the 10year G-sec vs Repo Rate has fallen to 5 years low

Source - Refinitiv, Quantum Research, Data as of June 19, 2023

Given the stretched valuations and near-term risk due to weak rainfall trend, we see a high possibility of long-term yields moving higher from current levels in near term. However, the upside on yields should be limited to 10-20 basis points given the overall macro backdrop is favourable.

Market condition for short term bonds have turned favorable with pause in rate hikes and prevailing easy liquidity condition.

At this stage, the 2-5 years maturity government bonds are attractively positioned with a medium-term outlook.

In line with our near-term cautious view, we maintain a lower portfolio duration in our actively managed bond fund as a tactical position. Notwithstanding the near-term concerns, we maintain our constructive outlook for long bonds in medium term. Thus, we shall look to add duration in market dips.

What should Investors do?

Although starting yield has come down from an earlier high level, there is decent accrual still available at current levels.

Even in the real term (adjusted for inflation), government bonds are still offering meaningful positive real yield. With expected CPI inflation of 5.1% (RBI’s FY24 inflation estimate) and a 1-year Gsec yield at 6.9%, the real yield is around 180 basis points.

Chart- III: Attractive real yields available across the government bond yield curve.

Attractive real yields available across the government bond yield curve

Source - Refinitiv, Quantum Research, Data as of June 19, 2023
#Real rates are based on the RBI’s FY24 average CPI inflation estimate of 5.1%.
Past Performance may or may not sustain in future

Overall, the return potential of fixed-income funds remains attractive , and the next three years are likely to be more rewarding for fixed-income investors than what we witnessed in the last three years.

We suggest investors with 2-3 years holding period should consider adding their allocation to dynamic bond funds.

Dynamic bond funds have the flexibility to change the portfolio positioning as per the evolving market conditions. This makes dynamic bond funds better suited for long-term investors in this volatile macro environment than other long-term bond fund categories.

A Dynamic Bond Fund or any other debt fund which invests in long-term debt instruments is highly sensitive to interest rate movements. Thus, in a short period of time, returns could be highly volatile and can even be negative. However, over a longer time frame of over 2-3 years period, returns tend to normalize along with the interest rate cycles.

Investors with shorter investment horizons and low-risk appetites should stick with liquid funds.

Since the interest rate on bank saving accounts are not likely to increase quickly while the returns from the liquid fund are already seeing an increase, investing in liquid funds looks more attractive for your surplus funds.

Investors with a short-term investment horizon and with little desire to take risks should invest in liquid funds which own government securities and do not invest in private sector companies which carry lower liquidity and higher risk of capital loss in case of default.

Portfolio Positioning

Scheme Name

Strategy

Quantum Liquid Fund

The scheme continues to invest in debt securities of up to 91 days of maturity issued by the government and selected public sector companies.

Quantum Dynamic Bond Fund

The scheme continues to invest in debt securities issued by the government and selected public sector companies.

The scheme follows an active duration management strategy and increases/decreases the portfolio’s sensitivity to interest rates in line with Interest Rate Outlook.

With sharp fall in bond yields, we have tactically reduced the portfolio duration in the QDBF portfolio by selling long term bonds while remain invested in GOI FRB and 1-4 year Government and PSU bonds to maintain accrual.


For any queries directly linked to the insights and data shared in the newsletter, please reach out to the author – Pankaj Pathak, Fund Manager – Fixed Income at [email protected].

For all other queries, please contact Neeraj Kotian – Area Manager, Quantum AMC at [email protected] / [email protected] or call him on Tel: 9833289034


Portfolio Information

Scheme Name: Quantum Liquid Fund

Description (if any)

Annualised Portfolio YTM*:

6.69%

Macaulay Duration

43 days

Residual Maturity

43 days

As on (Date)

31-05-2023

*in case of semi annual YTM, it will be annualised


Performance of the SchemeDirect Plan
Quantum Liquid Fund - Direct Plan - Growth Option
 Current Value ₹10,000 Invested at the beginning of a given period
PeriodScheme Returns (%)Tier 1 - Benchmark# Returns (%)Additional Benchmark Returns (%)##Scheme Returns(₹)Tier 1 - Benchmark# Returns (₹)Additional Benchmark Returns (₹)##
Since Inception (07th Apr 2006)6.74%6.79%6.09%30,62530,85727,597
May 31, 2013 to May 31, 2023 (10 years)**6.17%6.61%6.27%18,21118,98118,382
May 31, 2016 to May 31, 2023 (7 years)**5.26%5.70%5.85%14,32014,74714,886
May 31, 2018 to May 31, 2023 (5 years)**4.88%5.28%5.68%12,69312,93813,182
May 31, 2020 to May 31, 2023 (3 years)**4.17%4.47%4.20%11,30511,40311,313
May 31, 2022 to May 31, 2023 (1 year)**6.07%6.35%6.26%10,60710,63510,626
April 30, 2023 to May 31, 2023 (1 month)*6.93%7.04%7.36%10,05910,06010,063
May 16, 2023 to May 31, 2023 (15 days)*7.04%6.97%8.70%10,02910,02910,036
May 24, 2023 to May 31, 2023 (7 days)*6.50%6.54%5.91%10,01210,01310,011

#CRISIL Liquid Fund AI Index, ##CRISIL 1 year T-bill Index.
Past performance may or may not be sustained in the future.
Different Plans shall have a different expense structure.
*Simple Annualized.
**Returns for 1 year and above period are calculated on the basis of Compounded Annualized Growth Rate (CAGR).
Returns are net of total expenses.
The Scheme is managed by Mr. Pankaj Pathak. Click here for performance details of other funds managed by him.

Performance of the SchemeDirect Plan
Quantum Dynamic Bond Fund - Direct Plan - Growth Option
 Current Value ₹10,000 Invested at the beginning of a given period
PeriodScheme Returns (%)Tier 1 - Benchmark# Returns (%)Additional Benchmark Returns (%)##Scheme Returns (₹)Tier 1 - Benchmark# Returns (₹)Additional Benchmark Returns (₹)##
Since Inception (19th May 2015)7.79%7.72%6.38%18,28318,18316,438
May 31, 2016 to May 31, 2023 (7 years)7.53%7.54%6.06%16,63016,64215,095
May 31, 2018 to May 31, 2023 (5 years)7.35%8.02%6.84%14,25714,70813,922
May 29, 2020 to May 31, 2023 (3 years)5.06%5.19%3.16%11,59911,64310,979
May 31, 2022 to May 31, 2023 (1 year)7.90%9.04%10.04%10,79010,90411,004

#CRISIL Dynamic Bond Fund AIII-Index, ##CRISIL 10 Year Gilt Index.
Past performance may or may not be sustained in the future.
Different Plans shall have a different expense structure.
Returns are net of total expenses and are calculated on the basis of Compounded Annualized Growth Rate (CAGR).
The Scheme is managed by Mr. Pankaj Pathak. Click here for performance details of other funds managed by him.


Product Labeling

Name of the Scheme

This product is suitable for investors who are seeking*

Riskometer

Quantum Liquid Fund


An Open-ended Liquid Scheme. A relatively low interest rate risk and relatively low credit risk.

  • Income over the short term
  • Investments in debt / money market instruments

Quantum Liquid Fund

Investors understand that their principal will be at Low Risk

Quantum Dynamic Bond Fund


An Open-ended Dynamic Debt Scheme Investing Across Duration. A relatively high interest rate risk and relatively low credit risk.

  • Regular income over short to medium term and capital appreciation
  • Investment in Debt / Money Market Instruments / Government Securities

Quantum Dynamic Bond Fund

Investors understand that their principal will be at Low to Moderate Risk

* Investors should consult their financial advisers if in doubt about whether the product is suitable for them.


Potential Risk Class Matrix – Quantum Dynamic Bond Fund

Credit Risk →

Relatively LowModerate (Class B)Relatively High (Class C)

Interest Rate Risk↓

Relatively Low (Class I)

   
Moderate (Class II)   
Relatively High (Class III)A-III  
Potential Risk Class Matrix – Quantum Liquid Fund

Credit Risk →

Relatively LowModerate (Class B)Relatively High (Class C)

Interest Rate Risk↓

Relatively Low (Class I)A-I  
Moderate (Class II)   
Relatively High (Class III)   


Disclaimer, Statutory Details & Risk Factors:

The views expressed here in this article / video are for general information and reading purpose only and do not constitute any guidelines and recommendations on any course of action to be followed by the reader. Quantum AMC / Quantum Mutual Fund is not guaranteeing / offering / communicating any indicative yield on investments made in the scheme(s). The views are not meant to serve as a professional guide / investment advice / intended to be an offer or solicitation for the purchase or sale of any financial product or instrument or mutual fund units for the reader. The article has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Whilst no action has been solicited based upon the information provided herein, due care has been taken to ensure that the facts are accurate and views given are fair and reasonable as on date. Readers of this article should rely on information/data arising out of their own investigations and advised to seek independent professional advice and arrive at an informed decision before making any investments.


Mutual fund investments are subject to market risks read all scheme related documents carefully.

Above article is authored by Quantum.

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