Fixed Income| Looking back, looking ahead: Returns on debt Mutual Funds will be more realistic

December 11, 2020 3:45 AM

In March 2020, the bond market went into a freeze. Yield levels shot up. Even liquid funds gave negative returns for a few days. What happened?

Banks were not taking a view on building positions on bonds, due to uncertainty and approaching year-end.

By Joydeep Sen

While 2020 has been a challenging year for humans and for economies, it has been good for asset markets. The challenges posed by the economy or structural issues were compensated by central banks stepping in with liquidity and succour. While the debate rages on in the equity market between fundamental valuations and liquidity driven rally, in the bond market it is a little different.

Looking back

In March 2020, the bond market went into a freeze. Yield levels shot up. Even liquid funds gave negative returns for a few days. What happened?

l In the initial phase of work-from-home, trading volumes had sunk. People have internet at home, but there are specialised trading systems in the office. These things got sorted out gradually through VPN, etc., but that took some time.

l Banks were not taking a view on building positions on bonds, due to uncertainty and approaching year-end. They were just parking the surplus liquidity with RBI itself in reverse repo.

l FIIs /FPIs were selling heavily in March. In a market in standstill, this added to the problems.

l People were waiting for RBI measures. RBI was doing something (OMO, LTRO), but market participants expected more. And kept quiet, i.e., they were not buying.

l Sentiments being negative, mutual funds faced redemption pressure. This compounded the problems as there was more selling pressure on the market. Liquid funds anyway saw the customary March advance-tax related outflows.

l Safety was perceived in overnight funds, and everybody rushed there. Due to excessive demand in overnight funds or the TREPS market, rates came down drastically, but were positive. Overnight funds do not give negative returns.

l All these issues compounded and the volatility led to liquid funds giving negative returns for a few days.

Gradually things improved as RBI, intervened with incremental measures. The RBI Policy Review was preponed to March 27. Apart from the rate cut, the targeted long term repo operations (TLTRO) of Rs 1 lakh crore was meant for purchase of corporate bonds. It could not be used for purchase of G-Secs or parking with RBI in reverse repo. This helped the stagnant corporate bond market, as there was somebody to purchase, i.e., banks with the help of easy money from RBI. The TLTRO corporate bonds were free from mark-to-market volatility for banks. The next announcement on April 17 of TLTRO 2 was another positive. The purchases so far were in better quality bonds (PSU, AAA). The other segment (less than AAA / NBFCs) was not getting the support. TLTRO2 of Rs 50,000 crore was targeted to NBFCs and MFIs, and 50% of this was targeted to small / mid-sized NBFCs.

Over the course of the year, RBI kept the support systems on through rate cuts (repo rate cut by 1.15% since February 2020) and other measures—reverse repo was cut further to 3.35%, infusion of liquidity moving the effective overnight rate to reverse repo rate of 3.35% and even below rather than the repo rate of 4%, OMO purchases for the huge G-Sec borrowing programme, OMOs on State Development Loans, twist OMOs (purchase of long maturity G-Secs and simultaneous sale of short maturity papers to support the longer end of yield curve), etc. On top of this, RBI reiterated the commitment to maintain the accommodative stance on rates and support to the market into the next financial year.

Looking ahead

Yield levels remained supported by liquidity in 2020; 10-year G-Sec yield currently being sub 6% and 3-month Treasury Bill being less than the reverse repo rate of 3.35%. In 2021 as well, government borrowing is going to be huge, as it will take a long time to come back to fiscal prudence. As long as support from RBI remains, the market will be there where it is. However, somewhere in future, either in 2021 or later, RBI will have to think of exit from the excessive liquidity. That would be a turning point for yield levels in the bond market. For debt mutual fund investors, returns would be more realistic as the carry yield (portfolio YTMs) have eased in 2020 and the rally is more or less done.

The writer is a corporate trainer (debt markets) and an author

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