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Rajeev Thakkar
We were often asked why we did not have debt funds. Even the liquid fund we launched was due to persistent demand from customers and consulting partners.
We do not have short-term funds, medium-term funds, credit risk funds, investment funds or even a balanced / hybrid fund.
Although we have already talked about it in the past, I think it makes sense to articulate this in one place so that investors / advisers have a point of view on it.
I do not believe in a 100% share split
The fact that we do not have a loan fund does not mean that I am against investing in fixed income / debt. A retiree, dependent on the regular income of his accumulated savings, needs many fixed income / debt options. According to the financial plan, badet allocation based on risk appetite for many people may have a debt allowance. Almost everyone needs emergency fund allocation.
Having or not having debt funds has nothing to do with the need to place debt securities in individual investment portfolios.
Death of real return on a global scale
Debt managers and investors have faced a challenge: low interest rates. By the time I write these lines, bonds worth an estimated $ 13 trillion globally are trading at negative returns. This is not currently a problem in India. Although interest rates are somewhat low compared to the past, they are still in the positive territory, both in nominal and real terms (after inflation).
Our biggest competitor is the government / RBI
Although negative rates are not a challenge in India, another type of challenge exists. This challenge lies in the considerably higher interest rates offered on "small" savings and direct issuance of RBI bonds.
At the time I write these lines, 10-year government bonds of India are trading at a yield of 6.44% per annum. half-yearly difference).
At the same time, RBI issues bonds directly to the public at 7.75% per annum. for a term of 7 years.
Be aware that GOI marketable bonds and PSU bond yields are ahead of fund expenses. There would be management fees for each fund. These can range from 0.5% per year. at 1.5 per cent pa and would further reduce returns for investors. After deducting a 0.5% optimistic on returns before fees, we would still have 5.94% on 10-year government bonds and 6.8% on AAA bonds.
Why should an investor take the risk of market / interest rate risk / credit risk, etc.? if risk-free bonds are directly available at yields of up to 1.8% per annum?
Even in the short term, we have a lot of banks that offer 6 to 7% on the savings account. Savings account balances are protected up to Rs. 1 per account and, therefore, for many investors, they are a good alternative to liquid funds.
What about liquidity and taxation?
It is not that the higher returns of small economies and RBI bonds are hidden. Liquidity and taxation are probably the only selling points for mutual funds in debt securities. Let's see them one after the other.
Liquidity
Sometimes liquidity is desired, at other times it is not. If an investor only wants a regular income and does not require liquidity, the RBI bonds work perfectly. Bank deposits can also work well.
Taxation
With respect to taxation, there are ways to save tax that are even better than mutual funds, depending on the circumstances.
EPF, PPF and NPS are part of this for long-term savings / retirement. First, there is no monetary limit to the contribution of EPFO. The employee can also benefit from a voluntary contribution to the provident fund and obtain returns of up to 8.6% per annum. free of tax. Even businessmen and professionals can create their own organizations and become employees of this organization to enjoy the benefits of the Provident Fund / NPS.
There are, of course, non-taxable obligations for medium-term needs or to generate income.
These are all factors that make debt funds unattractive from an investor's point of view when considering alternatives. Now let's take a look at the problem from a cash point of view.
Instant liquidity for investors who invest in illiquid paper
The promise made to investors of open funds is that they can redeem funds at any time and obtain the net badet value amount up to a few days. However, non-government debt securities that are more liquid may be quite illiquid. In such a scenario, and especially when the announcement of an issuing company is unfavorable, the first buyers have an advantage over the remaining investors.
Unlike banks, mutual funds do not have a liquidity provider. Even if a financial management company really wants to evaluate a paper in default or downgraded to fair value, there is no reasonable basis for doing so. In the event of a failure of a corporate borrower, should the bond be badessed at 75%, 50% or 25% or should it be subject to a complete write-off? There is no good answer to these questions in the absence of negotiated price / estimation of the ultimate realization of the obligation / deadline for resolution.
We can not have an investment grade bond market in the absence of a junk bond market
Regardless of the efficiency of the auditors or the vigilance of the rating agencies. There will always be cases where an old investment grade bond will be downgraded to junk and / or default. It is not a question of relieving auditors / rating agencies of their recent shortcomings.
They certainly need to improve their game, but even in an ideal situation, there would be cases of bankruptcies or fraud well concealed.
We need a liquid bond market in which risk-taking buyers are there to buy downgraded / defaulted bonds at a price. This would allow the funds to properly market or sell impaired and defaulted bonds. In the absence of a high-yield bond market, the liquid market is limited to government bonds and perhaps to a handful of non-government borrowers.
We can not have a high yield bond market with no insolvency / bankruptcy law that works well
Who would buy degraded and defaulted bonds? There is no dearth of risk takers and bargain hunters if there is a well-established framework for recovering money.
If a debenture is secured by badets and there is a simple and quick mechanism to seize those badets and sell them, there would be a market for high risk bonds (less than investment grade bonds).
Although we have bankruptcy laws in place, there are currently many litigations involved and some strange decisions such as placing unsecured operational creditors on a par with secured creditors. The resolution time is also very long. Until these problems are solved, it is difficult to have a booming market of speculative bonds.
Access Issues for Bond Investors
In the equity market, every investor, regardless of size, has equal access. An individual shareholder can sell a share to a foreign pension fund seeking to purchase millions of shares through the anonymous electronic order reconciliation system. To enable this equal access, the stock exchanges and regulators have removed the minimum filling system and the order system based on all or no order in order to allow equal access to small investors.
The fixed income market is in complete contrast. Even when paper is liquid, minimum fill and All or None (AON) commands are commonplace and we encounter situations in which a buyer wants rupees. 5 crore investments can not buy because the seller will only sell in batches of Rs. 25 crores. Although any investor can open a dematerialized account and a brokerage account and buy shares, access to bond and money markets remains quite restrictive.
Why should anyone worry about it?
Long story short, why should we care? A well-functioning debt market is essential if we are to finance our infrastructure and our growth needs, especially when the banking sector is in crisis. We need it for the insurance and mutual fund industry to grow.
We must offer consistent returns to all investors and not select high returns to individuals. If, at the very least, older people are to be subsidized, this should be done through targeted pensions and not by offering high returns without discrimination for "small" savings.
The low high savings rates are one of the reasons why RBI rate reductions are not transmitted efficiently by the system. A rapid resolution process in case of default will have to be put in place and access to the debt and money market will have to be expanded instead of remaining a closed club.
I have not lost hope, maybe you will see a loan fund from PPFAS someday.
(The author is CIO, PPFAS Mutual Fund)
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