Should You Be Eyeing Debt Funds Right Now?
What should those investors do, who do not want volatility associated with equities, & find returns from bank deposits too low?
The policy measures announced by Reserve Bank of India were a much-needed antidote for the fixed income markets, in the midst of the Covid-19 crisis. Spikes in yields over the past couple of weeks had taken a toll on returns at short-term debt funds, mainly due to liquidity concerns in a volatile environment. The signs of stress were already there, and became glaringly evident on March 24, when, for half an hour after trading started, nobody bought or sold a bond on Reserve Bank of India’s platform. Volumes were just Rs 7,210 crore or $930 million as of close at 5 p.m. in Mumbai that day, compared with the year’s daily-average of Rs 45,000 crore.
The question is, after the heavy artillery pulled out by the central bank, what lies ahead for investors who do not want the volatility associated with the equity markets, and find the returns from safe bank deposits to be very low?
Note that SBI has already cut deposit rates across tenors by 20-100 basis points, effectively impacting the returns of deposit holders. Looking at it objectively , it would be a fair assumption that fixed income fund returns would likely be substantially higher than bank deposits.
Three Things To Consider
1. The RBI has said it was maintaining its accommodative stance and would maintain this position “as long as necessary” to revive growth. This effectively means that the cycle of cuts is nowhere close to over, and thus returns from deposits in banks would continue to languish.
2. Inflation is benign, and barring a weather disruption, we are unlikely to see any spikes which may prompt the central bank to be overly concerned about the rate cut trajectory. Lower crude prices only add to confidence in the lower inflation print.
3. The rate cuts, the language of the RBI governor, and the Targeted Long-Term Lending Operation announced on Friday are all interesting moves. It is now well-documented that through TLTRO, RBI will provide up to Rs 1 lakh crore to the banking system at a floating rate linked to the prevailing repo rate to fund all investment-grade debt market instruments. Thus, banks can now buy investment-grade corporate bonds and borrow against them, an option which did not exist until Friday.
As Suyash Choudhary of IDFC Mutual Fund says, ‘the design of the new program and the dispensations on fluctuation risk and exposure limits will hopefully restart banks’ appetite in quality money market and corporate bonds.’
The RBI announcement has already brought about a much-needed reaction in the yields of the corporate bonds. For June maturities, the yields on several corporate bonds corrected by 150-300 basis points. However, spreads over repo are still substantially higher than the average of the past few years, beckoning immediate action from investors.
Economic uncertainties are indeed hard to quantify. An unemotional look at market history indicates that a reversion to mean tends to occur when fear abates. It is probably this belief that is leading experts to advocate that short term funds might be a clincher in the current scenario. Granted, longer-end yields may not fall as much, as the markets will be concerned about the hazy economic outlook as well the increased borrowing by the government over the long term to meet the mammoth funding needs, and thus the bullishness for that duration won't be very high. It was evident on Friday as well, since we saw that even after the bazooka fired by the central bank, the 10-year government bond hardly budged. But the shorter end is a different story, and hence, short-term funds would be the investment story.
The immediate benefit of indexation, should one invest before March 31, is an added incentive.
Sunil Jhaveri, founder and chairman of MSJ Misterbond says the spreads between the repo rate to the 10-year AAA-rated bonds continue to give opportunity, even as the rates have come off. Jhaveri believes that the extra money with banks will continue to chase the AAA-rated bond segment, since bankers are still risk-averse, and hence the short term plans, with a 30-36 month maturities would be the place to invest in. Investing in AAA-rated PSU or corporate bond 10-year schemes following constantly rolling down strategy also gives good opportunities.
Gurmeet Chaddah of Complete Circle Consultants believes that with fixed deposit rates expected to fall to 4-5 percent, debt funds could do well. Corporate bonds that mature in 2-5 years have significant room for a further rally, and yields in that space could see a further dip of 75-100 basis points since the spread between repo rate and 3-year AAA paper is still in the vicinity of 220-240 basis points, which is significant. Investors with no liquidity should stay invested in funds owning high-quality portfolios. Investors having liquidity should invest in short-term funds with an average maturity of 1-2 years with a 100 percent AAA portfolio. For investors looking at a horizon of over three years, corporate bond funds and banking and PSU debt bunds with 30-42 month maturity and quality AAA portfolio are the best bet.
We have probably recovered from the point of maximum pessimism for the corporate debt market, and investors must realise that no one can necessarily time the bottom. Prudence may lie in still choosing wisely, and in a timely fashion. Investors need to be mindful of the fact that there will likely be volatility in the short-term. Most importantly, because of the fallout due to the IL&FS crisis on select funds, investors will be well-served if they carry out proper due diligence on the credit quality of the portfolio in which they choose to invest. Remember, not all horses end up winning. Some may fall by the wayside.
Niraj Shah is Markets Editor at BloombergQuint.