While spreads are tempting, it is unlikely that corporate bonds will recoup losses in a hurry. Reason - most debt funds are currently overweight on this segment after selling government securities to meet redemption
28-Sep-2001 •Research Desk
Government security or gilt funds may have smartly recovered but last fortnight's volatility has left a gaping hole in returns from most debt funds. Most investors may find it surprising since debt funds have traditionally been more stable than their gilt counterparts with faster recovery in net asset values. This time though, it has been different - while the average loss for gilt funds is 0.41 per cent, the losses are steeper at 0.64 per cent for bond funds.
Well, unlike last year, when interest rates were hiked and the entire interest rate paradigm had shifted upwards, there has been no such fundamental change now. Liquidity continues to be strong with RBI's repeated bias for lower interest rates. Hence, the first signs of stability have seen players log into sovereign bonds. On the other hand, the big buyers of corporate bonds - mutual funds are still absent from the market.
"Government security prices have largely recovered on the back of aggressive buying while there are no bids emerging for most corporate bonds,'' says Dhawal Dalal, fund manager, DSP Merrill Lynch Asset Management Company. "While gilt prices are now roughly 75 paise lower than pre-attack levels, corporate bond yields are still 40-50 basis points higher,'' concurs Rajiv Anand, head of investments, Stanchart mutual fund. Yields and bond prices move in opposite direction. Thus, corporate bonds still have a lot to catch up while it has been a swift recovery for gilts – the yield on a 10-year sovereign bond is at 9.3 per cent, a mere 14 basis points more than its September 11 level of 9.16 per cent.
The sudden demand for redemption in debt funds has also taken a toll on returns. With jittery investors pulling out, debt funds were forced to offload their gilt holdings in a panic-driven market. "Redemption has been one of the reasons why bond funds are lagging behind. Debt funds could only sell gilts in a falling market and those losses are now showing up. On the other hand, there was no such redemption pressure on gilt funds,'' points out Dalal. Thus, it has been a double whammy for bond funds. While corporate bonds have seen little gains, the gilt exposure for debt funds stands sharply reduced and cannot contribute in the current recovery.
The asset base has proved to be an impediment in such volatility. For instance, the average size of a gilt fund is only Rs 111 crore against Rs 700 crore for a bond fund. Thus, a slight tinkering (say, a deal of Rs 10-15 crore) can significantly alter maturity complexion and returns of a gilt fund. For a bond fund though, the selling has to be of a much larger magnitude.
Will Corporate bonds Recover?
It is unlikely that corporate bonds will recoup losses in a hurry. For one, most debt funds are currently overweight on corporate bonds after selling gilts to meet redemption. Thus, fund managers would rather opt for sovereign bonds to recharge their liquid assets. In the last couple of years, debt funds' dependence on gilts has gone up sharply with a sharp spurt in inflows.
Yet, some fund managers see demand for corporate bonds on the rise. "With attractive spreads over comparable G-secs, traders have started to buy corporate bonds,'' says Sashi Krishnan, fund manager, Cholamandalam Mutual Fund. "The spreads are surely tempting and could vary between 140 to 240 basis points amongst AAA bonds over gilt of comparable maturity. There is wide disparity and it is clearly a function of liquidity,'' says Dalal.
Yet, demand has to emanate from mutual funds to drive up prices. On the contrary, some debt funds are now also selling corporate bonds to meet demands for switchovers (to cash funds) and redemption. Further, fund managers need fresh cash to pick up attractively priced bonds, which can only happen in the event of fresh investments or if investors switch back to debt funds. However, with uncertainty still looming large, a move back to debt funds may not happen in the near term. Thus, debt fund investors will have to wait for some time before NAVs crawl back to pre-September 11 levels.
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