Last month, the winding up of six debt funds at Franklin Templeton shook the confidence of debt fund investors. Already, the on-going lockdown in India to tackle the spread of COVID-19 is expected to hit many businesses. Financial markets have been volatile. Investors wonder if debt funds are safe enough. Mahendra Kumar Jajoo, chief investment officer-fixed income, Mirae Asset Investment Managers (India), shares his views on these issues in an interview with Moneycontrol’s Nikhil Walavalkar. Excerpts:
In light of recent events, debt fund investors have been spooked by credit quality, illiquid securities, and a steeply falling economy. Are we likely to see more defaults from bond issuers?
Corporates have incurred fixed costs in the lockdown period. There will be costs when the work restarts. Also, the increase in working capital requirements and poor demand in the future will hit corporate profitability. The possibility of an extension in the social distancing norms may further adversely impact segments such as food retailing, malls, airlines and movie exhibition. Among non-banking finance companies (NBFCs), those focusing on affordable housing and tier -2 and tier-3 NBFCs may witness stress. Fintechs and NBFCs offering loans at point-of-sale counters may also face some challenges. The core industries such as steel and cement will revert to normalcy soon. The actual impact will also depend on the extent of fiscal support the government offers. So yes, some defaults – more than the yearly average so far – are expected.
After the recent event in debt schemes, have you done a stress test on the debt securities of your bond funds?
We continuously assess our investments. Our portfolio comprises good quality bonds. Things are in order. All our funds hold AAA securities and CRISIL has rated our short-term bond fund, CPR1.
Is it wise to restrict debt investments to traditional fixed income options such as bank fixed deposits and small saving schemes, despite their low interest rates?
Small saving schemes and bank fixed deposits make sense for small investors. However, individuals in the higher tax brackets need to strike a balance between safety of their capital and returns offered by the investments. For market-linked returns investors should opt for bond funds. Investors should consider the scheme objective and portfolio construction before investing.
Short-term debt funds investing in high-quality bonds maturing in one to three years look attractive. If you can stomach volatility, you can also consider long-term debt funds investing high-quality bonds.
Avoid credit risk funds.
What are the behavioural risks investors should avoid at this moment?
Investors need to overcome their fear. Avoid running away from volatility. When you choose a safe product such as bank fixed deposit over a bond fund, you forego a significant amount of return to satisfy your ‘safety need.’ The second issue is chasing high returns by taking undue credit risks. In India, the high credit-risk bonds have not historically outperformed high quality debt instruments. Investors need to strike a balance between fear and greed.
Given the massive liquidity infusion, there is a fear of hyper-inflation. Do you foresee such a situation?
Typically, after a war, earthquake and Tsunami there is a destruction of physical infrastructure. In those cases, the same need to be built again. So there is higher demand for materials, labour and capital, which in turn leads to inflation. In a pandemic, there is no destruction of infrastructure. However, it leads to job losses and closure of small business units. It means less demand after we re-open our economy. Hence, there is less chance that we will see hyper-inflation.
How do you see the government's borrowing play out in FY21?
The government has to offer fiscal stimulus to industries and financial aid to the public, especially the weaker sections of the society. The situation is evolving and it is difficult to project the numbers pertaining to the fiscal deficit and the amount of government borrowing. Going by the numbers of developed economies, we may see the fiscal deficit at 8 to 10 per cent of the gross domestic product. However, the priority now is to focus on supporting the economy and not to focus on fiscal deficit. The government may borrow as much as it can from the market and the Reserve Bank of India will finance the rest.