While any investor can open a demat account or a brokerage account and buy shares, the access to bond and money markets is still quite restrictive
By Rajeev Thakkar
A retired person depending on regular income from accumulated savings needs a lot of fixed income/debt options. Depending on the financial plan, risk appetite based asset allocation for many individuals may have a debt allocation.
Death of real yield globally
One challenge that debt managers/ investors have been facing is the low-interest-rate environment. Around $13 trillion bonds globally are trading at negative yields. This is currently not a problem in India. While interest rates are low as compared to the past, they are in positive territory, both in nominal and in real terms.
However, a different sort of a challenge exists. It is the higher interest rates on small savings and direct bond issuances from RBI. It is not that the higher yields on small savings and RBI bonds are hidden. Probably the only selling points for debt mutual funds are liquidity and taxation.
If an investor desires only regular income and does not require liquidity of the principal amount RBI bonds just work fine. Bank deposits may also work well. On taxation, there are avenues to save tax which are even better than mutual funds depending on the circumstances. The promise to investors of open-ended funds is that they can redeem funds anytime and get the NAV linked amount. However, debt investments beyond the most liquid government paper may get to be pretty illiquid. In such a scenario and especially where there is some adverse news on a corporate issuer, the early redeemers have an advantage on the remaining investors.
Unlike banks, mutual funds have no provider of liquidity. Even if there is genuine desire on the part of a fund house to value a defaulted or a downgraded paper at fair value there is no basis to do so. If a corporate borrower defaults, should the bond be valued at 75% or 50% or 25% or should there be a complete write-off? There is no right answer to such questions in the absence of a traded price/estimate of ultimate realisation on the bond/time taken for resolution.
Liquid junk bond market
There will always be cases where an erstwhile investment grade bond gets downgraded to junk and / or defaults. This is not to absolve auditors or rating agencies of their recent lapses. They surely need to improve their game but even in an ideal situation, there would be cases of business failures or well-hidden corporate frauds. We need a liquid junk bond market where risk taking buyers are there to buy downgraded / defaulted bonds at a price. This would enable funds to properly mark-to-market or sell downgraded and defaulted bonds. In the absence of a junk bond market, the liquid market gets restricted to just government bonds and maybe a handful of non-government borrowers.
There is no dearth of risk takers and bargain hunters if a well-established framework exists to recover money. If a debenture is secured by assets and there is a quick and easy mechanism to seize those assets and sell them, there would be a market for junk bonds.
Access issues for bond investors
In the equity market, an individual shareholder can sell one share to a foreign pension fund looking to buy millions of shares via the electronic anonymous order matching system. To enable this equal access, exchanges and regulators removed the minimum fill and All or None (AON)-based orders facility to enable equal access to small investors.
The fixed income market is in complete contrast. Even where some paper is liquid, minimum fill and AON orders are rampant and we have situations where a buyer wanting Rs 5 crore worth of investments cannot buy because the seller will sell only in lots of Rs 25 crore. While any investor can open a demat account and brokerage account and buy shares, the access to bond and money markets is still quite restrictive.
Why should anyone care?
A well-functioning debt market is essential if we are to fund our infrastructure and growth needs. We need it for the insurance and the mutual fund sector to grow. We need to offer uniform yields to all investors and not selective high yields to individuals. If at all senior citizens need to be subsidised, that should be through targeted pensions and not by offering indiscriminate high yields on small savings.
High small savings rates are a reason why RBI rate cuts are not transmitted through the system effectively.
The writer is CIO, PPFAS Mutual Fund