Morningstar Investment Conference – Day 1

Friday, October 21st, 2016

This years Morningstar Investment Conference covered a range of topics from some great speakers. The first day had Nandan Nilekani discuss the technology disruption in financial services. There was also a great panel on the current fixed income markets.  We have summarised some of these views in our post.

 

Disclaimer: The content below is for informational use only and should not be construed as investment advice. The views presented are of the speakers themselves and are not an endorsement by us.

 

Nandan Nilekani: The digital revolution in financial services

In the keynote presentation, Nandan Nilekani talked about the fintech revolution in India and outlined a few major trends that will shape the future of banking and the financial services industry:

  • Currently the Indian banking industry reaches very few households. Over the last few years there has been a shift in the Indian financial transactions from low volume, high value and high cost to one with high volume, low value and low cost. The implications of this shift are tremendous; as the cost of consumer acquisition cost comes down, the number of families that can be serviced by the financial industry can rise dramatically.
  • India is a mobile first country and is digitising much faster than anywhere else in the world. This enables a shift of credentials to move from proprietary to open format.
  • Switching costs are going down – and this can be both a good and a bad thing. Nandan gave the example of the mobile industry. Today, out of a billion phones in India, roughly six hundred million are unique customers, meaning many Indians have more than one phone. Indians add roughly 40 million new sim cards a month out of which only 2 million can be attributed to new customers. This implies that there is a lot of churn in the industry as people keep switching phones and getting new  sim cards frequently. This is likely to happen in the banking industry as well.
  • There is an increasing amount of data available about each customer and therefore solutions will get increasingly customised and granular
  • Business models are increasingly shifting away from fee and commission based models toward ones that are built on data. Mr. Nilekani compared the business models of Microsoft and Google. Microsoft used to charge for its software and use of its products, today Google gives away the same software for free and makes money from user data and advertising
  • Public sector banks are bogged down by a number of issues and will lose a lot of market share to the private sector. This can be directly compared to how MTNL lost market share to new age private telecom providers
  • With the advent of UPI, merchant payment models are ripe for disruption. Today a phone allows you to do merchant payments. Moreover, merchants have an incentive to use such a service because the digital trail from such payments enables them access to much needed credit. This will help to accelerate the move to the cashless economyMorningstar Investment Conference - Nandan Nilekani
  • Nandan also pointed out that interest rates will start to converge. The argument being that as more information is available about customers, the pricing of risk can be more finely tuned. This will help to compress the spread between the interest charged by a micro-finance institution or small finance bank and the interest charged by a full service bank.
  • Finally, the combination of Jan Dhan, Aadhar and the mobile phone (JAM trinity) and the India stack will lead to many new disruptive business models that will completely change the nature of financial services. He gave one such example of this with the payment banks. Today payment banks cannot accept more than one lakh as deposits. This has led payment banks to tie up with mutual funds to provide a sweep out facility. In effect a customer who deposits money in a payment bank will automatically get money market return which will in most cases be higher than bank savings rates. This can have a tremendous impact on bank CASA ratios and deposits and could be a major disruption of the existing system.Morningstar Investment Conference - Nandan Nilekani

Even though Mr. Nilekani is a very big techno-optimist, the trends that he outlined are very real. It is likely that the banking and financial services industry 10 years from now will be completely unrecognisable from the one that we have today.

 

Fixed Income Panel Discussion

Manish Dangi (Co-CIO, Birla Sunlife AMC), Rahul Bhuskute (Head Structured and Credit Investments, ICICI Prudential AMC) and Suyash Chaudhari (Head- Fixed Income, IDFC AMC)

 

This panel brought together some prominent bond fund managers to share their views on the market in light of the new central bank policy, dampened investor sentiment and a deteriorating credit environment.

On the last few years in fixed income:

Suyash outlined that the we have seen two major phases of easing by the Indian central bank recently. The first phase was when the RBI was purely doing rate cuts. The second and more recent phase has been the revamped liquidity stance. He mentioned that money markets are now far more efficient in transmission and that spreads have compressed substantially as well. Suyash questioned the new MPC targeting of inflation in the 4-6 per cent band versus the earlier framework and raised doubts about whether such a policy is appropriate at a time when India is experiencing peak cyclical disinflation.

Manish on the other hand was of the view that we are likely to have substantial structural disinflation for years to come. This is a direct result of the property price bust in India and is also supported by the fact that commodity prices are likely to stay low for the next 7-8 years. He believed that it was reasonable to expect the repo rate to come down to between 5.75-6 per cent in the next 3-6 months and that incremental response would be based on growth in the economy.

Rahul also countered Suyash’s point on credit spreads by saying that even though yields have come down, spreads have not tightened by more than 10 basis points. Going forward the credit spreads are likely to tighten more and that the demand supply is in favour of a credit strategy rather than duration.

On the macro scenario:

Manish outlined that other emerging markets have more relative value compared to emerging markets and so foreign fund flows have been chasing that over the last few months.

In terms of the governments finances, Suyash said that the budget targets have historically always been met either by deferring spending or by cutting back on discretionary spends. He also mentioned that in India the cost of money was not the issue. The key is the availability of money to fund the governments infrastructure agenda. The combination of the RBI being obstinate on its liquidity stance coupled with large supplies in terms of UDAY and government bond supplies could lead to a situation where fiscal easing could be a big risk.

On the current opportunities and risks in bond markets:

All three participants were of the view that the balance of risk is now favouring accrual and credit strategies. A large part of the rate cut cycle has made good returns on the duration strategy, however the next round of the rate cuts will likely be accompanied by much higher volatility. Suyash also pointed out the tradeoffs that investors are presented with at the bottom of the rate curve. Even though duration may not be a great strategy going forward, investors should question whether they are diluting their risk framework or appetite for a higher yield. While credit strategies have higher returns, the underlying are not  as liquid or well hedged as the g-sec market.


About the author

Rishad is the founder of Kairos Capital. He started his career with Standard Chartered Wealth Management and has extensive experience in markets, particularly in terms of mutual funds and stocks.

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