The valuation of non-traded corporate bonds has always been a vexed issue in the Indian fund industry. Now, in an attempt that could decisively alter the perception for bond funds, fund houses are unofficially deliberating on introduction of daily valuation for illiquid corporate securities. The non-traded component is currently valued every Wednesday on the basis of Valuecorp model. While discussions are underway, Fund Spy has reliably learnt that the industry is still divided on the issue of daily valuation. Thus, it may be some time before a consensus emerges. The regulators also favour more frequent pricing of the underlying portfolio, which would be fair to all investors.
Bond funds are currently trusted as placid and stable investment vehicles. However, the daily valuation could change all that. "In case the industry decides to value the assets daily, the income funds could become more volatile,'' says Sandesh Kirkire, fund manager at Kotak Mutual. Thus, it may also end the long-drawn fictitious argument that bond funds are far less volatile than government security or gilt funds. "If the assets are valued daily, it is only then that the NAV would be correct. Since corporate bonds are not valued daily due to a lack of depth in the market, you do not see the volatility in income funds. This is really a myth,'' elaborates Kirkire. Valuecorp's base yield matrix comprises of sovereign bonds with varying maturity. Thus, the daily gyrations in gilt prices will have a definite impact on the non-traded corporate bonds. "The NAVs would fluctuate more, without doubt. But then, if investors are allowed entry/exit on a daily basis, the NAVs too should be reflective of the intrinsic portfolio on a daily basis,'' concurs Binay Chandgothia, fixed income fund manager at IDBI Principal AMC.
However, a section of the fund industry believes that daily valuation may not be advantageous, since specific instruments do not see trades for days together. "I am not sure what purpose daily valuations of the corporate book serves. Over the last 4 days, the total trade has been a princely Rs 200 crores. Hence, price discovery is poor,'' counters Rajiv Anand, fund manager at Stanchart Mutual.
Will Debt Funds be as Volatile?
In the event of a regular pricing, investors will get a NAV that is closer to the intrinsic value of the holdings. At the same time, any price movements will also be captured daily and volatility in bond funds will go up. "In addition to interest rate risk, credit risk and liquidity risk, corporate bonds carry the "spread risk". This is a very high risk making corporate bonds far more volatile than gilts,'' says Kirkire.
Yet, gilt funds carry a larger interest rate risk due to higher portfolio maturity. For instance, the August's maturity was an average 7.16 years against 4.59 years for bond funds. "The gilt market is more active and hence, fund managers would typically run longer duration. This means a greater interest rate risk (than bonds funds),'' points out Anand.
Well, the actual impact will be known only if the industry agrees to daily valuation of non-traded bonds. But one thing is certain – the days of illusory stability tagged with bond funds may be numbered. So far, this category has been in great demand despite the accompanying credit risk. If volatility in bond funds escalates, the tide could turn in favour of gilt funds. "The gilt funds by their very nature offer the best marked to market values of all the assets. Further with a lack of credit risk, I believe that going forward we should see a greater appetite for gilt funds,'' gushes an enthusiastic gilt fund manager.