Decades gone, but corporate bond market still tries to find its rhythm

Nikhil Johri

Illiquidity in the corporate bond market has caused yet another upset -- the biggest one thus far involving nearly $4 billion. Franklin Templeton’s recent decision to wind up six of its debt funds with AUM (assets under management) of around Rs 25,000 crore was bound to happen.

As a CEO of four foreign asset managers in India (one American and three European) over 14 years, I have often faced this dilemma of expanding AUM in corporate bond funds. The challenge of negligible trading in bonds rated below AAA on most days puts the responsibility on the investment and compliance teams to assign appropriate valuations to such bonds so that daily NAVs can be computed meaningfully.

The task was made simpler when a few independent valuation companies such as CRISIL and ICRA started providing daily valuations for these bonds to AMCs (Asset Management Companies). But, as most of us know, this exercise only serves the purpose of computing NAVs. Most bonds in fund portfolios do not get traded frequently and hence, would quote quite differently, if traded.

The other key aspect is most retail investors do not completely comprehend the basics of debt funds even after two decades of investing in this asset class. They still believe that the returns are almost guaranteed or fixed in nature like the interest on bank deposits and that credit or market risks, if they arise at all, can somehow be managed by the AMC.

They invest in debt mutual funds (MFs) for their “fixed” returns on the basis of past performance and also the tax efficiency as provided by the funds. The added advantages of the daily liquidity window provided by MFs and the ability to get their funds seamlessly credited back to their bank accounts within T+1 or T+2 days make them even more attractive.

In investment terms, T stands for the transaction date when you buy or sell a stock, bond, exchange traded fund, or mutual fund. T+1 or T+2 is the settlement date of such security transactions. In other words, that denotes the transaction date plus one day or two days.

The obvious debate that has never been addressed conclusively is whether the current MF format of investing in other than AAA-rated credit funds is appropriate, given the lack of depth in the secondary markets for trading corporate bonds.

A distinctly better way is to manage less than AAA-rated funds on an AIF (Alternative Investment Fund) platform meant for professional investors. In the case of MFs, the format should be amended so that these funds only offer infrequent liquidity windows, say once a month, to investors. Also, the redemption payment cycles could be longer, say T+30.

The investment horizon for investors in these funds should also be much longer, say a minimum of 3-5 years. This will prompt investors to invest the money that they may need within a year in funds that are rated AAA by at least two rating agencies.

Corporate bond markets in India have taken several decades to develop and are yet almost entirely shallow. A prime reason being commercial banks, the largest players in the market, have no incentive or pressure to trade in the secondary market.

Even recently, in the case of a lack of sufficient response in the TLTRO (targeted long term repo operations) 2.0 auction conducted by the RBI (Reserve Bank), some banks have suggested that they be allowed to lend the money borrowed from the central bank as loans to borrowers instead of being asked to invest in their bonds.

And there you go again…

The author is the Founder and Chief Investment Officer of Trivantage Capital. Views are personal.