Safe investment options in the current scenario
Over the last couple of weeks, a lot of debt funds have reported a decline in their NAVs. In such a situation, what are your reasonable options to allocate your money safely?
Until two years back, all was good in the world of bond investing. The first debacle related to IL&FS fraud was reported in the last quarter of 2018. IL&FS image was no less than a pseudo-government organization.
The company was a massive financial conglomerate of 347 entities with an outstanding debt of over Rs 95,000 crore.
After the news came to public, Finance ministry appointed Uday Kotak along with other bureaucrats to resolve the debt situation of IL&FS but the situation is far away to be treated as resolved.
After IL&FS, Vodafone, PMC Bank and then Yes Bank followed suit.
As the industry was already dealing with the debt crisis, came along COVID 19.
During the first half of March 2020, I had gone for a 10-day Vipassana program. I had no access to the digital device during those 10-days, therefore was not aware of what was happening in the finance world.
Nifty50 was down by 25 per cent. There was a drop in the NAV of debt funds including liquid funds due to sudden increase in G-sec yields.
A lot of newspapers started writing articles to spread fear by comparing 2020 health crisis with the 2008 Global Financial Crisis (GFC).
All parts of the economy were grappling with the reality of pandemic and a lot of countries started imposing a lockdown. India also imposed a nationwide lockdown on 23rd March.
"History doesn't repeat itself, but it often rhymes." - Mark Twain
It took me a few days to read a lot on previous financial and health crisis. Spanish Flu of 1918 was the closest as far as health crisis goes.
Why the 2008 Global Financial Crisis (GFC) is not the right comparison to the current crisis?
Monday, September 15th 2008, I remember watching the news about Lehman Brothers collapse while having coffee in McKinsey cafeteria (Gurgaon office). My first thought was that this seems to be a US-specific issue.
India has always been a nation with conservative policies. RBI had never granted permission to financial institutions to invest in Collateralized Debt Obligations (CDOs). It was a problem of financial institutions who had invested in CDOs.
Additionally, back in 2008, India was growing and most of the companies were in a healthy state.
In 2020, most of the companies across the industry were already in a low to no growth scenario.
If the 2008 GFC crisis is not relevant, what is?
In 1929 Great Depression, central banks had no idea about the positive impact of pumping money in the economy whether by interest rate cuts or bond buybacks. Therefore, even the 1929 crisis is not relevant.
1918 Spanish Flu crisis is too old and the world healthcare has improved massively since then.
However, India was in a lockdown and economic activity was shut. Now the economy has started opening but a lot of businesses have not and will not go back to pre-COVID levels.
Fear spreads more than the disease itself.
The fear had spread and fear can make changes in the ‘tastes and preferences’ of consumers.
With no customers, there won’t be any cash flow and hence a lot of companies with loans may not be able to pay their loans or even interest.
What does this mean?
Companies would either default or their credit rating may go down. Irrespective, debt funds NAV will be marked down.
Economists throughout the world have realized that growth can be brought back by pumping money in the economy. The market expected the same from the RBI and finance ministry. Rate cuts and other reforms were announced.
Yields started going down and but credit opportunities fund started showing trouble signs. Those who invested in these funds committed asset allocation mistake, to begin with.
Irrespective of the time, you allocate in debt for SAFETY and not for return.
Over the last few years, I have allocated debt portion of assets directly in bonds than in fund structure due to more control. However, that approach may not be feasible for a lot of investors. Therefore, the choices that I am suggesting here may be restricted to only fund structure-based options.
Interest rates have gone down and are expected to go down further. In such a scenario, bank fixed deposits may not make a lot of sense. Here are the options for debt investing.
1. Liquid funds investing in government securities
A liquid fund invests in bonds that have a maturity of up to 3 months. The investments are primarily in government securities (RBI bonds). For the most part, there is no credit risk related to investment in these funds.
2. Short-term debt funds investing in high-quality debt funds
Short Duration debt funds usually have a duration of 1 – 3 years. Theoretically, you can expect to earn higher returns than a fixed deposit with a bank, but the underlying investments are the key. Unlike, a fixed deposit, there is no guarantee of return.
3. Arbitrage funds
Arbitrage funds generate returns by engaging in arbitrage opportunities and taking advantage of the spread or the differential in the price of a stock in the spot market (that is the stock market) versus its price in the futures market. Most stocks generally trade at a premium in the futures market (unless the market sentiment turns very bearish) and this provides the spread.
The choice of these options or maybe a combination would depend upon your individual needs. The safest option would be liquid funds investing in treasury bills, followed by Short-term debt funds allocating funds in high-quality companies and then the arbitrage funds.
Plutus Capital’s Investment advisory service is specific to the client’s objective and profile. A debt portion of the investment may include tax-free bonds, high-quality corporate bonds, RBI bonds, sovereign bond funds and/or arbitrage-based equity investing.