Debt market’s love for G-Secs & PSU papers is here to stay
Risk of a high-quality portfolio is volatility, as underlying securities are traded frequently.
by Long & Short of Bonds
Investors put money in debt mutual funds to get stable returns. The return on a debt portfolio is broken into two parts: the income which is the coupon/yield to maturity (YTM) of the underlying securities in the portfolio, and the price appreciation of securities in the portfolio.
Analysing the total returns over a longer time frame, 80-85 per cent of returns is generated by YTM of the portfolio and the balance 15-20 per cent by capital appreciation.
In the past, retail and HNI investors have always been inclined towards schemes that offered higher YTM. YTM is the stable part of the returns of the portfolio. The risk of a high-quality portfolio is volatility, as the underlying securities are traded frequently.
However, we are seeing a shift of retail and HNI investors from credit funds to good quality portfolios this financial year. Lower GDP growth and high leverage of Indian companies have led to credit quality deterioration and security prices moving down/marked down in a portfolio. It is because of this that the returns of high yielding portfolios have not matched the YTM of the portfolio.
Yields on government securities and ‘AAA’-rated PSU papers have come down due to RBI cutting repo and reverse repo rates by 225 basis points and 265 basis points in the last one year. RBI has been conducting Open Market Operations, switches in government securities to bring down yields. High quality corporate bond paper yields have also come down due to the unconventional measures taken by RBI like targeted long-term repo operations. RBI has infused around Rs 8 lakh crore of liquidity in the system, which has compelled the banks to invest in the absence of credit offtake.
Yields have not fallen on ‘AA’ and below rated papers of reputed companies. They are trading in the 8.50-9 per cent band in the three-year segment. This is giving a spread of 400 basis points over G-sec of similar maturity. These are some of the highest spreads that have been available in good reputed ‘AA’ names since 2013.
Why then are fund managers not buying these papers of reputed companies given the low default risk probability?. Credit rating agencies have an upgrade-to-downgrade ratio of 1 :10 in value terms for this financial year. Given the demand destruction, there is expectation of more than one downgrades in many of these companies. Fund managers do not want to trade their liquidity for higher YTM in these uncertain times.
The government is not inclined to spend its way out of this problem, as most countries have done to tackle the Covid-related disruptions in their economies. The total fiscal deficit of state and Centre should be around 80 per cent of GDP in 2021 from 69 per cent in 2020. The government seems to be worried about the risk of global rating agencies downgrading the country’s rating taking it to non-investment grade.
This could make Indian companies access to the capital markets problematic. This will also increase the risk premium that investors will demand to invest in this country.
The downturn in GDP growth is expected to be longer in India compared with other countries. Indian economy may take more than three years to recover fully to pre-Covid levels. The reform package announced by the government will take time as the private sector, consumers deleverage their balance sheets. RBI will be expected to do a lot from the monetary policy side to take care of deficient demand conditions in the economy.
We may be heading for low interest rates in the economy for a long period as consumers hold back their purchases and producers hold back investments due to the uncertainty of the evolving situation. Banks and other intermediators like insurers and mutual funds are flushed with deposits/inflows due to lack of investment opportunities. Given the risk-averse environment, they will plough back the money in government and ‘AAA’ rated PSU papers even though the yields on these instruments have come down below historical standards.
RBI is expected to support this segment of the market as they are the largest borrowers and their spending has the highest multiplier effect on the economy.
(The views expressed in this article are personal and the author in no way is trying to predict the market or time it. The views expressed are for information purpose only and should not construed as investment, legal or taxation advice. Please consult your financial/investment adviser before investing.)