The liquidity squeeze in the financial markets has a most unlikely beneficiary-retirement funds. With banks playing safe and mutual funds? debt portfolios dwindling, even the best-rated Indian companies are paying more to raise debt?spreads between 10-year government securities and top-rated corporate paper jumped sharply to 3.85% last month from 1.21% in July. To cash in on this unprecedented premium, savvy company-run provident fund (PF) trusts are enhancing their fund allocations for corporate bonds.
With banks andMFs staying away from the corporate debt market, PFs are probably the only investors still active in the segment, according to investment bankers involved in placing AAA-rated PSU debt in recent weeks. Banks and treasuries usually trade in corporate paper while PFs must hold their securities till maturity.
As they need to match the EPF rate declared by the labour ministry, company-run PF trusts have had a tough time in recent years as earnings were always lower than the ?politically fixed? EPF rate. The rules require companies to make up for any shortfall in their PFs? income with their own cash. Consider: when gilts saw their biggest bull run in 2002-03, the yields on government bonds were around 6-6.5% and the EPF rate was 9.5%.
?With elections around the corner, companies are worried that the EPF rate may go up this year. Moreover, they see the spurt in bond yields as an opportunity to make up for losses in recent years,? said Amit Gopal, VP, India Life Capital.
It?s not just corporate debt that PFs are loading up. At least a third of the PF trusts are actively seeking government permission to try and switch from the low-yielding government securities bought in recent years to new securities. Oil bonds, for instance, that were bought four years ago with 6.5% returns, are now available for above 9%.
Replacing old bonds will hurt as their prices have tanked. But companies are choosing between taking a 10-12% hit this year and getting higher returns over the tenure of the new paper or staying invested in existing securities while running the risk of subsidising the EPF rate again.
Switching securities requires a nod from the PF commissioner and if a PF is selling an old gilt paper, it cannot replace it with anything but gilt paper. In the hope that the spreads between gilts and corporate paper will stay for a while, some PF trusts are replacing their old gilt papers with fresh gilt paper of shorter tenure, like those maturing in April 2009. When these bonds mature, PFs would be free to invest them in any category.
Current guidelines allow the 2,500-odd company-run PF trusts to invest 30% of their funds into bonds issued by public sector units and public financial institutions and 10% of corpus into corporate bonds. PFs also have the discretion to allocate an additional 20% of their portfolio into any of the permitted investments. This means that trusts can scale up their exposure to private or public corporate debt to as much as 60%.
With yields on corporate bonds rising sharply in recent months, those who bought them six months ago would be hammered on a mark-to-market basis. Indian PFs, however, are not required to mark their holdings to market.