Bond market investors are flocking to safety!

Last updated: 25 Jun, 2020 | 04:30 pm

Bond market investors are flocking to safety!

What’s happening to the economy

  • The aftermath of the spread of COVID has been devastating for businesses due to the shutdown of economic activity across the globe.
  • Indian businesses are suffering due to a drop in consumption, driven by lockdowns as well as a drop in trade (exports and imports). It can be seen from the chart below.
  • As a result, there is heightened risk in the economy, and hence creditworthiness of businesses in India is under the scanner.
  • This has resulted in investors flocking to pockets of safety in the fixed income market.

What’s happening in the bond market

  • Interest rates have been cut by a massive 1.15% by the RBI this calendar year. This has resulted in a fall of yields of all fixed-income assets.
  • However, there is an interesting trend emerging between the highest-rated AAA bonds versus AA+ bonds (which are just one rating notch below).
  • AAA bonds would typically constitute bonds by issuers such as (HDFC Bank, Baja Finance, Larsen & Toubro) whereas AA+ bonds would be companies like (Shriram Transport Finance, Hero Fincorp and Cholamandalam Investment and Finance)
  • While yields of AAA-rated bonds have fallen in the last 6 months, yields of AA+ and that of AA bonds have actually increased! A clear indicator of very low demand for bonds in India deemed even slightly risky. The yields of AA+ and AA bonds should have decreased with a decrease in interest rates but as investors and institutions sold these bonds in large quantities, their yields actually increased.
  • Below is an example of bonds by two large corporate houses in India. L&T Finance (AAA) which has a Market Cap of Rs.13,500 crores, and Shriram Transport Finance Company (AA+) with a Market Cap of Rs.15,400 crores. This example considers zero-coupon bonds of both companies maturing in 2024.

How does this impact your investments

  • Yields of AA+ rated bonds will be disproportionately in the current market environment and given that they are just one notch below the highest rating, they may seem attractive to invest in.
  • Current economic factors signal high levels of risk to businesses and the effects of these risks will be particularly acute in sub-par bonds. 
  • FII’s have been selling out of India’s debt markets with net outflows in April, May and June even as Equities have seen inflows.
  • The risk to return on any sub-par debt (Below AAA-rated) is not favourable right now. Do not chase yields that AA+ bonds may offer, as it is better to err on the side of caution in this economic environment.
  • Stick to safer AAA Bonds and debt funds which have a high allocation to the same

Reach out to your personal family wealth office to help you with appropriate asset allocation in these volatile times!

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