Bond market investors are flocking to safety!
Last updated: 25 Jun, 2020 | 04:30 pm
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!