Massive opportunity for debt fund investors
Fundamentally, India is well placed in terms of macro-economic position to handle the lockdown due to the falling crude prices, moderate inflationary pressure and one of the highest foreign exchange reserves in the emerging world economies
Last fortnight, I'd mentioned about silver lining in this market mayhem. Back in 2008, I recollect having an interaction with my then company's Chief Investment Officer at an event. I'd an opportunity interact for about half-an-hour in-person as there was a miscommunication about the event timings. He apprised me about how the debt markets have turned attractive and was able to generate over 20 per cent returns.
This was just about the same time that year, as the crisis began to unravel across the world. He explained to me that bond investment is seen by many only for interest earning or coupon, but many neglect the possibility of capital gains. This is particularly attractive when the interest rates are decreasing as the bond prices have an inverse relation to that of the rates.
International Monetary Fund (IMF) has announced that the world economy is now in recession and termed the current outbreak as a gigantic crisis. The IMF chief opined that the length and breadth of this recession depend on two things: containing the virus and having an effective, coordinated response to the crisis.
Across the world, the central banks have resorted to sharp cuts in the lending rates to spur sagging economies hit by the virus outbreak. This is coupled with fiscal measures and economic packages announced by the governments. Reserve Bank of India (RBI) has also announced an unscheduled steep rate cut of 75 basis points (bps), which makes the debt market as attractive as 12 years back.
The unprecedented scenario of a three-week lockdown needs some unconventional strategies and RBI has shown its intent by cutting the reverse-repo i.e. the rate earned by banks by depositing money with RBI, by 90 bps. This creates disincentive for the banks to hoard their cash with RBI and also helps in transmission of the rate cut advantage to the masses. The latter has been a concern during the last few cuts.
Though unlike the last crisis of 2008, this is not a financial one and is coming on the heels of an already slowed world economy partly due to the trade wars. Unlike the last episode, we're still facing the hangovers from the remedies of last recession, with increased debt and ballooned balance sheets of the central banks while there is too little leeway in terms of monetary policy for the developed economies.
Fundamentally, India is well placed in terms of macro-economic position to handle the lockdown due to the falling crude prices, moderate inflationary pressure and one of the highest foreign exchange reserves in the emerging world economies. With the flight to safety for liquidity across the world, the existing lower Foreign Portfolio Investors (FPI) exposure to debt also helped for India. The overall benign credit demand in the last few quarters, especially since the Sept 2018 due to the IL&FS fiasco, allowed many corporates to deleverage compared to the previous years.
Debt mutual funds invest in corporate bonds (CB), Commercial Paper (CP), Government Securities (G-Sec) and Non-Convertible Debentures (NCD), etc. depending upon the fund objectives. The exposure or proportion will vary with the objective of the fund and its investment philosophy. The long-term funds include the duration i.e. G-sec which benefit from the changes in the bond prices due to volatility while the medium-term funds include investing primarily for accrual i.e. interest income and the shorter end funds concentrate on the liquidity aspect.
The US dollar liquidity turned out to be a major concern with FPIs pulling out from riskier assets across the world and trying to remain in cash. This has led to sharp increases in the yields though the G-Secs remained range bound, the disparity has gradually increased in the spreads between AAA and AA- rated bonds. The yields on the shorter tenor also has increased significantly due to sharp increase in the investors' preference for liquidity.
The Targeted Long-Term Repo Operations (TLTRO) conducted by RBI has brought not just liquidity to the banks but also helped in reducing the spreads which would happen in further instalments. While the fiscal policy has targeted at easing hardships of people, monetary policy has infused the much-needed liquidity to encourage banks to purchase investment grade NCDs, CPs, and corporate bonds over-and-above their outstanding investments. Just to get an understanding of these operations, the scale is closer to about one-third of the whole debt mutual fund industry assets.
The TLTRO brings in the necessary symmetry in inducing into those areas of economy which lacked substantial flows. These help the banks to not just to make fresh purchases i.e. from the primary market but also from the existing pool i.e. from the secondary market also. This is thus presenting a massive opportunity for the investors to take advantage of the credit risk which is permanent while the market risks are temporary. Investors could explore better placed funds for the medium-term though across the tenor opportunities persist.
(The author is a co-founder of "Wealocity", a wealth management firm and could be reached at firstname.lastname@example.org)