“Reminiscence: Indian Debt Market” by Mr. Santosh Kamath at First India Fixed Income Summit, Chennai 2019

Speaker: Santosh Kamath, MD and CIO Fixed Income, Franklin Templeton Asset Management

Moderated by: Sriram Mahadevan, CFA, Principal – Azim Premji Foundation

Contributed By: Deivanai Arunachalam

Fixed Income Summit

The Fixed Income Market doesn’t get the importance it deserves. It was in fact the first market worldwide. Why are FI markets so critical? Only if FI markets are efficient, do you get rates for equity valuation. The FI space answers a lot of questions including which discount rates to use when interest rates are negative.

An efficient market needs different players with different risk appetites, different horizons and perspectives.

Old days

Bond markets are valued completely on an appraisal basis. 15 years ago, when there was no way you could mark to market, how did funds manage?

The frequency of NAVs we had made it difficult to monitor funds on an everyday basis. It was natural for rating agencies to change their stance after a few months. Crisil was then given a mandate that their rating should be stable for a period of 5 years. We have often bought at the previous week’s NAV. Eventually we could see values for Monday, Wednesday and Friday. The momentum soon picked up and we had everyday NAVs. ETFs today Mark-to-market every second.

Similarly, we had only a 1-year certificate of deposit in those days. It soon paved way for the introduction of the 3-month CD and now we have even 1-month CDs.

The speaker also recall days when we’ve had nightmares about how to fund redemption. We’ve come a long way since then.

Compared to the times when share certificates were received in trucks to the dematerialised form in which we trade today, the equity market has seen a sea change. The fixed income market has been slower in its transformation. The Fixed Income market was opened to foreign investors as recently as 2000. There were many constraints and so markets were not fully efficient and even today we have a long way to go.

In the early days, the FI market was all about issuing low coupon bonds. The period from 1995 to 2000 saw several reforms culminating in the introduction of repo instruments in 2000. We have gradually moved to an anonymous trading platform.

Is it Fixed Income?

Due to its name, it has created an expectation that one should get a fixed return. This is especially true in India. A change in this mindset is necessary to help the market develop further. In 2008 a Korean liquid mutual fund gave a negative return for one day, when rates were very high. The fund had to shut down. When rates go up sharply, what does a fund manager do?

Mutual Funds are significant in size, scale and complexity. They are the most agile institutional investors. It was discussed that EPFOs should also be marked to market. Since there is no incentive for them to trade, they only buy. If they feel yields are going to increase, they should sell. This would increase market efficiency.

EPFOs and Fixed Deposits offer a fixed rate of return, say 8%. Regardless of the movement in market interest rates, the Indian investor expects the sacrosanct return of 8%. Unfortunately, in India we have a PSU bank culture – the investor believes that the bank will repay his money. The investor does not fear losing his investment. Assume that there were no PSU banks and there are only private/foreign banks. When one gets too comfortable with fixed return, one is clearly not comfortable with the mark-to-market impact.

Markets have tolerance for losses but not for noises. When equity funds give negative returns for a few days, we call it short term volatility. But if the same thing happens in the debt market, it is perceived as a problem. This is not a problem or an accident; it is the way the market is.

Sriram wondered if keeping sight of the scams we have seen historically and the bouts of volatility, (including the Harshad Mehta scam, or the Asian crisis which was a fixed income induced crisis), if it is time that we stopped calling it Fixed Income.

We should call it debt markets. It was called Fixed Income because of the fixed coupon attached to the instruments. SEBI has a regulation that if you have a credit fund, it should be called a credit risk fund.

Being a Fund Manager

There are 2 key qualities needed to be a debt fund manager:

1. She should have a strong view

2. Should be open-minded to accept that she can be wrong.

It is noticed that many people don’t have an open mind. So, there is a high chance of failure.

Dynamics between regulators and market players

Regulators’ mindset is different from that of the market players. Market players would want a free hand, to generate extra alpha. Regulators would try to curtail risk given that we handle public money. There is a healthy balance in the dynamics between the regulators and the market players.

Too many restrictions make it tough for the fund manager.

There is always the question of doing the right thing versus doing what the investor wants.

The equity market has indices that are better followed. Public attention to debt markets is much lower. A luxury that we (at Franklin) have is that we have been here for 60-70 years. There is no pressure to please investors. Companies are now more investment driven than sales driven. Having been in the industry for so long, one has some wisdom. Sometimes there’s also a feeling that people cannot question you.

In developed countries, market forces and players brought about development in the market. The regulator just steps in to ensure that markets are orderly. However, in India, the regulator had to step in to develop the market too, noted Sriram. That happens when a country’s Per Capita Income is low, and infrastructure is not well developed.

Imagine a situation in which you are a coal miner, earning 10K per month. You put in money into a Provident Fund. It becomes unthinkable for the Government to tell him after 5 years, that his principal has come down, because the investor’s income is low. Over a period of time, it is possible for the Government to introduce improvements. For instance, the Government has introduced a Defined Contribution plan for new employees in the place of the existing Defined Benefit plan. So, we are slowly getting there.

It never crosses the investor’s mind that a PSU bank can fail. In 2002-03, when there was a lot of stress in the bank, Indian bank still managed to collect the highest amount of deposits.

Way ahead

The speaker strong believes that there is also a need for different types of products to ensure efficiency.  In this context, he is a supporter of Bond ETFs. It is a good initiative. But we’ll have to wait and watch if it succeeds.

Access to Indian sovereign bonds is institution-driven and not so much retail-driven.

Sriram observed that in the recent past, there were negative returns for 4 funds. He asked if we are seeing investors mature or if we are handcuffed volunteers.

Investors are becoming more sophisticated in their outlook. They realise that when they earn 5.5% to 6% in a liquid fund for a year, one day’s negative return is hardly anything compared to the service it provides.

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