Madhushudan Kela, head of equities and Sunil Singhania, fund manager of Reliance Mutual Fund state that they have seen significant interest coming back to fixed income.

According to them, interest rates and inflation may start moderating. They state that earnings growth is likely to slow down, as compared to the previous years.

Reliance MF has been slow to deploy cash raised by new schemes. They have increased cash levels across schemes to 15-20 per cent. They believe that sizeable redemption from equity products has not been seen.

Excerpts from CNBC-TV18's exclusive interview with Madhusudan Kela and Sunil Singhania:

What has been your experience; since you have won awards for both the fixed income side and the equity side - are you seeing a little bit more by way of even interest in both kind of products now?

Kela: I think we have seen - because of interest rate hardening - significant interest coming back into fixed income products. If you take the double indexation benefit, now people are making more than 10 per cent return tax-free on the fixed income products. Clearly some amount of money is moving into fixed income, which was restricted 6-12 months ago.

Reliance Growth Fund got the silver medal, if you will, among equity funds - on what parameters was it ranked across what kind of funds because it has been quite challenging in the last few months for the mutual fund industry, particularly for diversified equity funds?

Singhania: They take risk-adjusted parameters - which is their proprietary tool, and rank it for a longer period of time, so there are one year, five year and 10 year rankings. Luckily for us, all our hard work has paid up and the consistency of the returns won us the accolades.

Has the universe of stocks you are looking at in the Growth Fund become narrower in the past few months?

Singhania: I won't say narrow but valuations obviously have been challenging. We have been saying this for a long time that stock specific movements are what is going to determine whether you will be able to do well or not.

Sensex movements have become very erratic, some stocks have been doing well, a lot of them have not been doing well. So, stock selection has become all the more important, rather than in 2003-2004 when there was a wide variety of stocks, which were undervalued. Now obviously the undervaluation to that extent has become narrower, so the role has become more challenging.

Kela: If you see the Index movement and the stock movement from even January of this year, out of top 50 Nifty companies, only five of them have had positive returns and only five of them have beaten Nifty and definitely 35-40 stocks are underperforming Nifty, and some of them by a significant margin.

So the game is clearly turned down from top-down to basically what stocks you own in your portfolio and that is what is going to determine your returns.

What has your experience been on the equity products that you have? Are you seeing redemption pressure or are you seeing money being shifted into fixed income plans, or are you being able to raise fresh money for your fixed income products?

Kela: I think this is fresh money, which is being raised for the fixed income products because equity allocation out of the total overall saving is yet 3-4 per cent in India, so we are not seeing a significant shift away from equity to fixed income.

However, I think people who want to put incremental money of their savings in the markets prefer fixed income products, over the last three months or so. But we have not seen any redemption of any size in our equity funds in the last three months.

How significantly has the game changed - whichever way you look at it - because of interest rates hardening? Has it changed your view as an asset management company or investors' views towards the market?

Kela: I think, because of the low base, it is not getting very pronounced, but when we go and talk to investors and distributors, they are definitely much more cautious. People who are very aggressive on equity, they are wanting to do a SIP (Systematic Investment Plan) for instance, that I do not want to take a market call but whatever equity investment I want to do, I want to stagger it over the next 12 months.

But we have not seen any scare as such that there is 10 per cent redemption in two days in your fund, but that we have not seen in our equity products.

As a fund manager how has your outlook changed because interest rates have hardened and there is a general apprehension that earnings growth might start slowing down in the next three-four quarters?

Singhania: Earning growth vis-�-vis the last 2-3 years definitely will slow down. In the short-term, we will be dependent on how the global markets and interest rates pan out in the next 2-3 months.

But over a long-term period, we believe that the interest rates will start moderating, inflation will start moderating and the growth should continue in this country at least for the next 3-5 years.

As far as our strategies are concerned, strategies for different funds have been different. As far as growth is concerned, what we have been trying to do is pick stocks on the midcap side where there is sustainability and visibility of earnings.

In fact, the forward PE informally, which we have calculated as per our own earnings estimate in the growth fund for FY08, has fallen to something like 10-11 times. So to that extent we have been trying and de-risking our portfolios depending on the schemes and the philosophies of those gains.

Cash also has been one instrument, which we have used very judiciously and from time to time, we have increased or decreased our cash levels between 5-15 per cent, in some cases even to 20 per cent. So it is more dynamic right now than it was six months back, but it's a challenge and we have to face it.

There has not been a whole lot of buying though by mutual funds through the month, nearly $350 million has been sold. Tactically, at this point where would your cash levels be?

Singhania: As a fund house, we have approximately 15-18 per cent cash but depending on different schemes like in the new scheme, which we launched, we have nearly 50 per cent cash and we have been very slow in deploying fresh investments.

In growth scheme we have around 15 per cent cash and in some other schemes, we have between 5-15 per cent cash. So depending on the scheme and the philosophy the cash levels are varied but as a fund house we would be having approximately 15-18 per cent cash.

Cash level seems to be on the higher side compared to an average, does that mean that you expect to find better prices in the foreseeable future?

Kela: We definitely are looking at buying better stocks at reasonable prices. So we are looking to buy what we want to buy and not just buy any stock, so that is what is holding us and that is what is holding the cash. I have not yet found the levels where we are comfortable investing aggressively.

Given the uncertainties, which are looming ahead of us, whether it is inflation, interest rate, global scenario or money moving a little bit away from equity to fixed income, in this scenario, you don't need to be over aggressive or over excited to buy companies. This is when you get bargain and this is when you get bargain prices.

What's your gut feeling in the next 4-6 months - will it be a bit more difficult to raise cash, whether it is for existing plans or any new ones that you might have in your pipeline?

Kela: I think it is going to be difficult because the environment clearly has changed. So raising new money is going to be difficult, at least in the next 4-6 months.

In a couple of your larger plans, you had the flexibility of using Futures & Options quite actively. Have you been doing that and for the last 2-3 months, have you actually had Nifty shorts or Nifty hedges to protect your portfolio?

Kela: Yes, in one of our largest schemes, which was essentially a long short fund, we have had more than 15 per cent cash in the large fund and we have had hedging as per what we promised to our investors, which even includes stock futures short as well as Nifty shorts depending on what our view is.

Interestingly, one of your awards has come from the Reliance Banking Fund, a sector, which is been under tensed pressure over the past many months, though recently it recovered a bit. What is your call on that sector given where interest rates might be heading or have come to?

Singhania: The long-term call on the sector is very positive; we have seen advances grow at nearly 30 per cent. The deposits, which were lagging behind the advances, have now picked up with all this money flowing into the debt schemes and going forward there is going to be more equilibrium, as far as advances and deposits is concerned for the banking sector.

Obviously, in a rising interest rate scenario, the psychology is to be away from financials because they might be impacted by higher provisioning, but the way the banking system in India is panned out and the way they have made themselves efficient added by the regulations, which basically helped them settle their outstanding or the NPAs better, I think the future for the banking sector over the next three-five years is definitely good.

In the short-term, it is more news flow, which is impacting the valuations rather than fundamentals. As far as fundamentals are concerned, we are hopeful that earnings growth will continue at the rate, which they are.

And as far as the PSU banks are concerned there are a lot of PSU banks, which traded well below their book values with decent return on capital between 15-20 per cent, so it's a good sector to be in.