In an insightful conversation, Gautam Kaul, Senior Fund Manager – Permanent Income at Bandhan AMC, breaks how expensive a crucial role plays in improving the return during a falling tariff environment.
From the mechanics of price sensitivity to strategy shifts for different investors profiles, Kaul offers a clear route map for navigating bond markets in a changing tariff cycle. Edited fragments –
Kshitij Anand: For investors, in particular stores, can you give them a small master class on how tariff reductions influence the question of investors for different agencies of corporate bonds? I am sure that many new investors – or the gene z “you could say – don’t relate much to how ties work. There is often more fear than accurate knowledge. So if you could simplify this comparison for them, that would be really great.
Gautam Kaul: When you invest in a fixed income instrument, there are two broad risks that you are exposed to – expensive and assessment. Assessment refers to the credit risk that is related to the bond. Duration refers to the weighted average maturity of all cash flows of the bond.
To simplify, the sensitivity of the price of a bond for interest movement is measured by its duration. For example, if a bond has a duration of one, the price of the bond for a change of 1% in the returns will rise or fall by 1%.
Similarly, if the bond has a duration of 10, an interest rate change with 1% would cause a 10% change in the bond price – plus or min. There is a little nuance in it, but that is the basic principle. Why is this important? Because when interest rates rise or fall, the impact of Mark-to-Market (MTM) on your portfolio is governed by the duration of the bond. Bond returns come from two components: the coupon (or wear) and the MTM impact. Unless you hold a bond to the due date, your return of holding the coupon you earn exists – usually most of the efficiency and structured daily – and every MTM win or loss. So taking our earlier example: if your bond drops a duration of one and interest rates by 1%, you drop 1% of the MTM in addition to your regular coupon. If you are selling at that time, that MTM win will be realized.
When we talk to investors about fixed -income values, we encourage them to look at two risks: endurance risk, which drives the volatility of a bond fund and credit risk. These are the most important parameters that you must evaluate before you choose which funds you should invest.
Sebi helped here by his categorization framework. For example, liquid funds cannot invest in instruments with maturities after 90 days; Low-duration funds are limited in one year; Short -term funds have defined endurance tires. Investors therefore get a clear idea of the maximum and minimum endurance risk that a fund can wear.
Short-term funds, for example, must enforce a Macaulay duration between one and three. So in that case your MTM impact can vary from 1% to 3% for a change of 1% in interest rates.
Earlier it was relatively easy to assess the endurance risk of a portfolio, but much more difficult to assess credit risk. You had to dig in facts and manually check the reviews of each company. But a few years ago, Sebi introduced the Matrix of Potential Risk Class (PRC) – a simple but powerful tool.
It requires each fixed income fund to define the maximum level of endurance risk and credit risk that it can take.
For example, if a fund explains as a PRC “A” about credit risk, this means that the average portfolio rating of the fund will be AAA at all times. If the PRC is “B”, the average assessment must be at least AA.
This gives the investor a clear picture of the maximum credit and endurance risks related to the fund – two of the most critical parameters in investing in fixing values.
So if you do nothing else, just look at the PRC classification. It gives you a reliable, future -oriented measure of the risk profile of the fund.
Kshitij Anand: Apart from that, looking at the industry in a broader sense – do you see the Indian bond market coming up as a relatively safe haven in the midst of global debt uncertainty?
Gautam Kaul: Oh yes, absolutely. I would even say that India, if not unique, is certainly one of the few economies that offers both macro -economic stability and high yields.
In order to give a context-long-term investors with a fixed income, try to retain the purchasing power of their money in the first place. That means earning efficiency that beats inflation, which is the holy grail. Achieving that consistent macrostability requires: a low tax deficit, low and stable inflation, and ideally a manageable shortage in the current account.
India checks all those boxes. Our shortage in the current account is low and stable. We are less exposed to rates compared to economies such as Southeast Asia or China, which are highly dependent on the export of production. Our export is predominantly based on services, which are more isolated from global rate issues.
Inflation is also well under control – lower than the prediction of the RBI and far below the upper tolerance level. The government has been tax -responsible for tax purposes, which reduces the tax deficit year after year (except during the COVID period, where even when the spending was focused and controlled). They have also committed themselves to lower the debt-to-GDP ratio over time.
These are precisely the statistics that every global allocator looks with fixed income. As a result, global investors have already started considering India as a port with a fixed income, even before our admission to the JP Morgan Bond Index.
Consider this example: if you compare two countries where the tax deficit rises from 5.5% to 6.5-7% and another where it drops from 5.5% to 4.5%-you assume that the latter is a developed market and the former one came up. But in the case of India it is the opposite. That speaks volumes about our policy strength.
And all this did not happen by accident – it is the result of deliberate, disciplined policy decisions. For a worldwide allocator with a fixed income, this indicates a stable environment with attractive returns.
Another important point: foreign ownership of Indian government bonds is still quite low – even after JP Morgan Inclusion, it is less than 3%. For comparison: many other emerging markets have foreign ownership ranging between 5-15%.
So yes, India offers an attractive macro landscape, a deep and growing market and a lot of headroom for increased foreign participation. I believe we are well positioned to become a preferred destination for global allocations with fixed -income values.
Kshitij Anand: Let me also get your perspective on ESG – one of the most important themes that originated on equity and on bond markets. Delete investors a valuation premium to companies that issue ESG-compliant bonds, and what drives the growing popularity of these instruments?
Gautam Kaul: ESG as a movement – and the associated market – has received a considerable traction and momentum in the West. In India we are still at a very early stage of the entire ESG investment platform. Even in our landscape, Equity sees where we see more traction compared to fixed income.
That said, we have seen some private corporates publishing ESG bonds. In fact, the Indian government also publishes green bonds. So there is a joint effort, and of course a demand for these instruments from specific segments.
From a fixed income perspective, the market is still on the rise and develops. The majority of the demand for ESG bonds currently comes from foreign investors instead of domestic.
I believe that as consciousness grows, we could also see the investments in ESG bonds in India with ESG-Dedicated Funds. There is a great potential here, but we are still in the early days.
Does the market pay an important premium for ESG bonds? Selective, yes. But it still has to evolve into a more widespread and common practice.
For example, the loan costs of the government for green bonds versus regular bonds are not very different, for example, only a premium of 5-based point.
When green bonds were first introduced, our feeling was that this premium – or “greenium”, as it is called – could be much higher. That can still be the case in the future, given the early phase of the INR -abligation market.
(Disclaimer: recommendations, suggestions, views and opinions of experts are their own. These do not represent the views of economic times)
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