AMC Speaks: How much of industry debt fund AuM is at risk now?
Zoher Doctorr
| How much of industry debt fund AuM is at risk now? | |||
| Lakshmi Iyer, Head of Fixed Income & Products, Kotak MF | |||
While investors are evaluating additional tax liability on their debt fund income, the MF industry is evaluating which segments of debt funds now become less competitive and therefore how much of industry AuM is potentially at risk. The fund industry has made its representations to SEBI and the Finance Ministry and everyone is keeping their fingers crossed. Which product categories are really vulnerable, beyond FMPs which is the most obvious one? How much money is there in these products? Will the industry be able to handle redemption pressure, if any? We turned to Lakshmi Iyer, who gives us a detailed perspective for each product category in the fixed income space. Read on to understand which categories are potentially at risk and also which categories continue to stand tall despite the tax advantage being withdrawn. | |||
WF: Taxation changes on debt funds have indeed come as a bolt out of the blue for the industry. Can you please share your perspectives on the business implications across all fixed income product categories - from liquid funds right upto duration based income and gilt funds? What we are keen to understand is which segments are likely to be most impacted, how large are these impacted segments and what are systemic risks, if any for the impacted segments. Also, which segments in your view now look the most attractive for investors. Lakshmi: Lets start with the ultra short term category - liquid and liquid plus funds. With DDT now being levied on gross basis, there is no post tax arbitrage left. This means that ultra short term funds will need to compete with short term bank deposits on a pre-tax return basis. Banks cannot accept deposits for less than 7 days and in any case, they are usually not very aggressive with their deposit rates in this time bucket, as it increases their overall funding costs. I don't see any near term threats of ultra short term funds delivering less returns than 7 day bank deposits. A large part of liquid fund corpuses in the industry come from corporate investors. I don't think anything significant has changed for this segment. In the liquid plus space, individual investors who have been using these funds for 3-4 month parking purposes, will now have short term bank deposits as an alternative. But here again, I don't see liquid plus funds turning uncompetitive as of now, versus 3 month bank deposits. The next category is FMPs. This is where the industry has got its biggest jolt. FMPs today are around Rs.170,000 in industry AuM, and at least 80% of this is in the 1 year segment. With long term capital gains tax now available only for 3 year plus holding periods, the 1 year FMP loses its tax advantage and much of its post-tax attractiveness versus 1 year bank deposits. I think the industry will now shift towards 3 year plus FMPs, where the post tax yields will still be competitive versus bank FDs. However, this will also make FMPs purely for individual investors as corporate investors are unlikely to lock in money for 3 years. There is still space for FMPs, but the category is most likely to shrink considerably in the coming months. Then comes the short term and medium term funds category. This is split into two segments - the pure short term funds with a high proportion of AAA and gilts and the accrual based funds that invest in a wide spectrum of corporate bonds. Pure short term funds, which are around Rs.40,000 odd crores in industry AuM will now have to compete head on with one year bank deposits on a pre-tax basis, due to the withdrawal of tax benefits. This segment will be sensitive to what banks do from time to time on their 1 year FD rates. Banks are quite active in raising funds in this segment. Accrual strategy based corporate bond funds is where I see the best opportunities going forward for the industry and for distributors. This segment has been growing rapidly, its now around Rs.45000 crores at an industry level, and it sees significant flows from non-institutional money, which is also quite sticky in nature. By definition itself, corporate bonds should yield typically higher than bank deposits - and that spread will continue to make accrual based funds attractive, even on a pre-tax basis. That said, since a lot of this money is individual money, I think there is an opportunity to engage with investors and seek longer term money - 3 year plus - in this segment. If we are able to do that, the tax benefits will also be available to investors, which will make these funds even more attractive. I think there is a big opportunity for all of us to pitch accrual based funds as part of the core long term debt portion of the asset allocation for any investor. As an aside, when we launched our Kotak Medium Term Fund, we in fact made exactly this pitch - when we asked for allocations to this fund as part of the core long term debt portion of investors' asset allocation. An accrual based strategy is less prone to cyclicality that impacts duration strategies, and therefore can be offered as a long term investment with a lot more confidence. Today, the industry's short term funds are in a band of 9.2% to 9.5% on a YTM basis. Accrual based corporate bond funds are typically 1% to 1.5% higher on a YTM basis. This should give you an idea of why they should always remain competitive versus bank deposits, even on a pre-tax basis. The last segment is income and gilt funds - the duration plays. My sense is that most investors come into this segment more as a tactical play on interest rates falling, and not as part of a long term strategy. To that extent, investors will continue to consider this segment when they believe there are gains to be made in a declining interest rate environment, and tax is a lower consideration in their decision making variables. 10 year G-Sec yields are around 8.8% now and we believe we are heading into a stable to benign interest rate environment in the next 12-18 months. In such a scenario, it is possible to make a double digit return on duration funds, going forward, as the interest rate environment gets progressively more benign. This potential for double digit returns, I think, will still be attractive to investors, even though the tax benefits may have gone away. WF: Thanks for that detailed category wise perspective. One fear in the market now is about redemptions from short term funds and how the industry is geared to handle it. Where in your view, is the pressure point? Lakshmi: From a perspective of pressure points, you need to dissect the market into gilts and corporate paper. Gilts are liquid, there is really no pressure likely to build up on these holdings. Pressure points, if they were to develop, could be in the 9 months to 2 year segment of corporate papers - the CP, CD and corporate bond market. Last Friday - the day after the Budget announcement, we did see some selling. There were takers for CDs, albeit at 15-20 bps higher yields. Corporate bonds are however less liquid. That said, we did see RBI stepping in with a 5000 crores repo to keep overnight rates in check. As long as RBI continues to support the overnight market as and when it sees any liquidity strain developing, I think there is no reason to get unduly worried. http://www.wealthforumezine.net/AMCSpeakKotak150714.html#.U8X7l5SSzWc ********** | |||