Written By: – Seerat Arora (Product Lead & Senior Vice President – Centrum Wealth Ltd.)
“Strength lies in differences not in similarities”
We all like to have the variety in everything and rightly so from pen, outfit to even our selection of cars. However, the big question is “Why we ignore the Strategic Allocation in our portfolios and rather we only do the tactical one i.e. just moving one stock to another”
Stock Markets are always erratic; no one can anticipate the price and which is not only derived from company’s fundamentals but anomalies also play big role and which certainly depend upon our emotional quotient (usually some negative economic news may hurt the stock market in a whole). Hence, we can conclude the Standard Deviation is quite high when we think of the Equity Market. Here the question is how we deal this the adversities, which is unforeseen and always give us panic attacks.
Significant part (if not equal) of the portfolio can also be Debt, which can be considered as “Flight to Safety” as it helps you to diversify your portfolio and provides you a predictable income stream. It’s always advisable to have the buffer for Debt allocation in your portfolio.
Gradual shift of higher allocation to debt should be there and there are some reasons, let’s explore some of them-
Debt Investment in form of Fixed Deposits, Provident Funds, Bonds: Govt & Corporate (Non-Convertible Debentures) & the advance form of Debt can be counted as Market Linked Debentures (MLDs).
Fixed Deposits Easily accessible, are secured by Banks and are RBI licensed. RBI (Reserve Bank of India) always comes to rescue if any event happened with a Bank with which you make the deposit. Investment in Fixed deposits can be counted as good if we see the Risk-Return profile, and eminent due to the periodic cash payments. We see some of the banks started giving this feature like Unity Small Finance Bank (USFB) where the risk is same as the commercial banks.
Provident Funds do not provide you the liquidity and Tax Saving cap upto 1.5 lakh only.
Bonds-
“A cheap stock can stay cheap forever, but if you own a bankrupt bond, the process of emerging from bankruptcy and distributing new securities offers a practical catalyst to realize the value” – Seth Klarman
What exactly are Bonds? Are financial instruments that promise to give you the pre-determined (fixed) periodic coupon and pay back the principal (invested capital) on Maturity. These instruments are issued by Government bodies (called G-Sec in India) and Corporates (called Non-Convertible Debentures – NCD)
You are lending money to the government/corporate if you as an investor in Bonds. Bonds issued by government mostly for the Social Welfare Projects, Infrastructure Development, Subsidies etc.
G-Secs are considered to be the Risk-free securities as, are backed by the country’s Sovereign.
While, Corporate Bonds vary considerably in terms of risk; depends upon the creditworthiness of the Issuer. For instance high-rated Corporate Bonds (AAA+, AA: also called High Quality / Investment Grade) are less risky, strong credit quality, high probability of meeting their obligations. Investment Grade Issuers tend to have lower leverage, more revenue diversity, stronger cash flows, better liquidity and more conservative financial policies. While low rated ones (BB, B: also called High Yield) carry higher default risk. Hence, choose the ones to put your capital that align with your financial goals and risk appetite.
You must spread your investment across different bonds issued by various companies / sectors (like tech, healthcare, finance) as well as government bonds. This way, if one bond or sector does not do well, it won’t hurt your entire investment.
Major risks are Interest Rate Risk or Duration Risk-
Duration is a measure of the sensitivity, expressed as a number of years; of the price of a bond to a change in interest rates. Typically rising interest rates means falling bond prices, and vice versa for declining interest rates.
Bond Price solely depends upon the Interest Rate movement; we see the continuous uptick in the Interest Rate off lately where the bonds in hands of the investors lost value and on the other side investing in such bonds is lucrative for the new entrants, but one should understand the risk and reward before making investment decisions.
We all know about the inverse relationship between Interest Rate (YTM) and Bond Prices. Now in future if we expect the Interest Rates to go down, value of Bonds will go up. Hence Risk-Reward needs to be understood before putting money in debt segment.
We all see in the-
Interim Budget: Last fiscal Govt borrowing stood at ₹15.43 lakh crore vs government plans to sell Bonds worth ₹14.13 lakh crore in FY25, which is even lower than ₹15.2 lakh crore (estimated number by Bloomberg survey). It gives the RBI room to cut rates earlier. After the announcement of lower than expected government borrowings & fiscal deficit; the 10Y Bond Yield fell as much as 9 bps to 7.05% and while 14Y Bond Yield note fell by 12 basis points. Further drop in yields is expected due to flows from foreign institutional investors and further expectation of India’s rating upgrade – says Murthy Nagarajan, Head of Fixed Income, Tata Asset Management.
Corporate Bonds:
According to revised Reserve Bank of India rules: Effective 01-Apr-2024, Corporate Bond investments will be allowed under Held-To-Maturity (HTM) category for the first time with no cap, provided the fair value is disclosed and investments protected from Mark-to-Market.
Bond should be passed in SPPI (Solely Payment of Principal & Interest) i.e. Bonds acquired with the intention of holding to maturity would be classified under the HTM category, not Mark to Market as per the new rules.
Banks were earlier not buying with the fear of the price movement. This new rule will encourage bank’s treasuries to step their deployment in this debt asset class. Consequently, demand for the corporate bonds will be encouraged henceforward and bring real boost to the Bond market.
[As per RBI data, scheduled commercial banks invested around ₹ 11 Trillion in Corporate bonds in 2022, of which ₹ 7.6 trillion was invested by public-sector banks]
Govt also took a very good initiative in Union Budget 2022 based on the proposal from SEBI; called “Backstop Facility” – This facility will be an entity that can trade in relatively illiquid investment-grade Corporate Bonds and be readily available when there are stressed times to buy such bonds from various market participants especially in the secondary market to protect Fixed Income investors; is spectacularly an elevation to the Debt asset allocation.
Further, the regulator has mentioned about the pipeline of other proposals being worked on to increase confidence in the corporate bond market.
One more idea to promote the Corporate Bonds to bump-up the Credit Spread, which is possible with G-Sec Yield curve to be established via Foreign Interest expected to come to India. Hence, the G-Sec Yield should go on and the Corp Bond Yield (benchmark) should be enhanced with addition of Credit Spread.
Imagine a scenario where Bond Market participants from different institutions collaborate to develop a new sustainable Bond framework. They can establish standardized criteria for evaluating environment, social, and governance (ESG) factors in Bond issuances. This collaborative effort not only promotes responsible investing but also attracts a broader investor base interested in sustainable finance.
Furthermore, the cross-border participants can leverage collective intelligence to identify investment opportunities, assess systemic risks, enhance market stability, ensure the smooth functioning of the Bond market, and optimize portfolio strategies; which will further unlock synergies to benefit the overall Bond market.
Technology has democratically opens the doors of the bond market to a broader range of investors, where Big Data centralization helps in price discovery, liquidity risk management, intelligence gathering, pre-trade and post-trade analytics can be performed and lead to increase the efficiency in the Bond market and enhance the understanding of credit risk valuation.
Artificial Intelligence (AI) application utilizing deep historical data records of fundamental data elements (Bond quotations, audited statements etc).
In Mar’24, RBI announced the sale of Sovereign Bonds worth₹ 12,000 crore through two tranches in Apr-Sep as Foreign Portfolio Investors (FPI) now registered with Securities Exchange Board of India (SEBI) and can invest in Sovereign Bonds. Proceeds of these Bonds are certainly used for environmentally sustainable projects.
Notably, Hong Kong government recently utilized block chain technology for state-issued tokenized green bonds worth $ 102 million. Correspondingly Germany based engineering company ‘Siemens’ issued its inaugural digital bonds valued at $ 64 million through block chain platform.
Suffice to say, In the recent times, India sees growing in Bond Market in space of Democratization to open platform for all types of investors.
Fund raising through Debt also encourages economic development, the foremost purpose for corporate bonds is business expansion, building new entities, Infrastructure development, also repaying the current debt in order to mitigate the risk of default for the issuer’s own.
MLDs (Market Linked Debentures) – quite often we hear the name in our Indian Capital markets; globally known as “Structured Products” and where it mislaid the charm after Finance Bill 2023, where Govt ceased the Tax Advantage (earlier 20% LTCG and STCG at slab rate).
Notwithstanding after all this, MLDs (Structured Products) still maintain the creativity, which will surely keep them alive and sustainable and preferred product segment for investors have the higher allocation in their portfolios especially MLDs. Advantages can be counted as Capital Protection, Hybrid Product Offerings (Debt+Equity), Transparency in the design, Mechanically managed and no Fund Manager intervention is required (unlike Mutual Funds), Investors are not entangled with the Binary Output and MLDs claim to transfer you the returns in mediocre markets and many more.
