The attractive valuation spreads over GSecs and favorable demand-supply dynamics should keep Corporate bonds attractive. Also, given the lack of catalysts to shift the yield curve downwards, the long end should likely be volatile despite being attractively valued.
Credit markets have been roiling with a series of rating downgrades since August 2018 starting with IL&FS, Zee Group, Reliance ADAG Group and now DHFL.
This has also led to banks and mutual funds (being key lenders) being risk-averse in lending to non-banking firms (NBFC/HFC).
NBFCs with higher real estate lending portfolios have been punished severely. This could have a spiralling impact on mutual funds (MFs) having exposures to them.
Over the past four years, the credit outlook has been drifting weaker. Credit ratio (upgrade to downgrades ratio) trends have been gradually sinking lower and lower.
No wonder then that credit spreads (spread between corporate bond yields and government securities) have widened and been attractive for a while. On the other hand, the supply of corporate bonds has slowed after the IL&FS debacle.
GoI has announced H1FY20 net borrowings at a 7-year high of Rs 3.4 lakh crore with front-loaded borrowings and back-ended redemptions.
About Rs 1.43 lakh crore is going to be issued in the 10-14 year bucket leading to over-supply of G-Secs and pressure on yields of that tenure.
Overall, the outlook for the long term, G-Secs should be cautious in the near to medium term, given factors like unfavourable demand-supply conditions, inflation and fiscal deficit concerns.
The attractive valuation spreads over G-Secs and favourable demand-supply dynamics should keep corporate bonds attractive. Also, given the lack of catalysts to shift the yield curve downwards, the long end should likely be volatile despite being attractively valued.
Potential liquidity improvement efforts could help short-term bonds/funds positively.
Bond funds come with two key risks: interest rate and credit risk.
An investor’s objectives to deploy in debt funds are the safety of principal, liquidity and returns in that order of priority. In the current environment, one has to see the trade-off between assumable risks and investor objectives.
Given the current market conditions and risk-reward, investors are better off in Ultra Short, Low Duration, Short Term and Corporate Bond Funds depending upon their investment horizon.
Credit risk funds and funds with meaningful exposure to below AA rating in any category do not appear to offer favourable risk-reward and hence, we suggest to avoid this category of funds.
Allocations meant for liquidity management should be kept in Overnight and Arbitrage Funds. Given the broader risk aversion and credit environment, we suggest investing in open-ended funds or liquid instruments.
The author is CIO of WGC Wealth.Disclaimer: The views and investment tips expressed by investment expert on Moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.Subscribe to Moneycontrol Pro and gain access to curated markets data, exclusive trading recommendations, independent equity analysis, actionable investment ideas, nuanced takes on macro, corporate and policy actions, practical insights from market gurus and much more.