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We did an interactive Debt Fund Masterclass Webinar a few weeks ago. In the three-hour session, Deepak covers everything from the basics to what investors need to watch out for when investing in Debt (Fixed Income) in India. This post summarises Deepak’s answers to some of the questions that came up during the session.
On AT1 Bonds
Why were AT1 bonds written off while shareprice did not go to zero? Bondholders have first claim, not the equity holders?
We speak about this in our post on the Yes Bank rescue.
But “Additional” Tier 1 bonds are like this: The bank has to have capital against the loans it lends. The bank can raise equity by selling shares. But that dilutes everyone if you have to constantly do that. So, there are other “quasi equity” things you can issue, under Basel III regulations. One of them is something called a perpetual debt instrument (“Perpetual AT1 bond”). Such bonds have structures like this:
- It will not have a maturity date (“Perpetual”)
- The bank can choose to call it back after 10 years by paying back principal and interest
- The investor cannot force the bank to call it back, no matter what
- On a trigger event like profits not being enough, the bank can refuse to pay interest for any year
- On a trigger like capital ratios falling too low, the bank along with RBI can lower the principal amount on the bond without the investor having any say, all the way to zero.
This then becomes as good as equity for the purpose of capital adequacy since the bank can choose to not pay back any money or interest. But what’s in it for the investor? A slightly higher interest rate. Yes bank perpetual AT1 bonds were trading at 10% or so. Which attracted a lot of investors, including mutual funds, insurance companies and even NBFCs.
Now, given the situation, Yes Bank needs to be resolved, so the AT1 bonds have been cut to zero.
The company has full discretion to pay or not pay the interest on AT1? Irrespective of its net earnings?
Not full discretion, but with consultation with RBI they do have discretion. Bondholder input is not required.
So what is the advantage to buy AT1 bonds apart from interest rate ? Why company refuse to pay ?
No advantage other than interest rate. In fact, only disadvantages. We speak about this in our post on the Yes Bank rescue.
On investing / trading individual bonds
Sir recently nse started its gobid plstform for bond market. is it wise to take bond directly instead of debt funds?
No, there are tax advantages to owning bonds through funds. You don’t have to pay tax on the interest when a mutual fund receives it, and if a fund sells a bond it doesn’t pay capital gains tax. You can keep holding while a fund rolls its securities over after maturity.
When the bonds are traded the buyer pays the seller two components – bond price + the accrued interest b/w last coupon date till the transaction date?
Yes. This is in the wholesale market.
In certain bonds, in the retail market (where funds don’t really operate) we might see the accrued interest as part of the quoted price. This is called the “dirty” price and includes accrued interest, in which case you pay only the quoted price.
How do we buy a particular NCD/Bond that was initially issued on a Private Placement Basis? Is there any platform to see what all Private Placement NCD’s/ Bonds are on offer?
You can buy this offline – there are now some providers that will offer them on a secondary basis, but this is a one-on-one quote between you and the third party. There’s no platform with quotes, per se. But you can see all traded bonds (after they have been traded) on a platform like NSE or https://www.bricsonline.net/bonds/BondsTradedToday
Can retail buyers buy CP/CD from secondary market ?
We are unsure of the exact rules here, but it appears that retail are not easily allowed. You may need to set up a company for this.
Are there opportunities for retail traders to make money in bonds trading? Or is it the big guys’s domain?
At Capitalmind Premium, we have spoken of a number of opportunities in bond trading and in fact made profits on a number of such trades. See:
- https://capitalmind.in/bonds
- https://premium.capitalmind.in/2018/10/bond-baba-how-to-build-a-high-yield-bond-portfolio-using-retail-bonds-in-crazy-times/
- https://premium.capitalmind.in/2016/12/bond-baba-is-pleased-with-the-srtransfin-bonds-12-return/
[Note: Some of these need Premium access]
How to asset allocate safely so that risk is hedged, between equity and debt: especially how to account for tail event risks?
You need an overall asset allocation in place that you rebalance back to once every year. Read our posts on what asset allocation actually works in India:
How to think about Asset Allocation in India: Part 1 (general access) and Part 2 (premium)
On Bond Basics
How to judge whether interest rate will increase or decrease in future?
Complex but usually a factor of inflation. If inflation is rising, the RBI is likely to increase rates.
What are CBLOs v/s net current assets vs payables/receivable?
CBLO is a Collateralized Borrowing and Lending Obligation. It’s just a way to park money for the very short term. Payables are when you’ve bought a bond and not paid for it. Receivables are when you’ve sold but the money hasn’t yet come.
What are the options for short term government bonds in mutual funds?
Use a liquid fund that does primarily govt bonds. A few mutual funds have that kind of profile.
What is FRD?
Floating Rate Deposit. The interest rate is “reset” every once in a while, and that reset is linked to a “benchmark” rate – which can be MIBOR (an interbank daily rate), RBI Repo (set by RBI) or a market linked rate like a 3 month government bond yield.
TREPS is secured lending? Is there a big difference b/w interest rates charged for TREPS vs CPs?
The Tripartite repo is a secured form of lending and typically happens at lower rates than a CP.
What is the exact difference between Corporate bond and corporate deposit?
A corporate bond may not allow you to call back the bond at any time you like, but usually a corporate deposit will have a clause to allow you. Also, you can’t sell the corporate deposit to someone else – but you can sell the bond.
What does guaranteed in secured bonds mean ?
It means someone else is guaranteeing that if the issuer doesn’t pay, they will pay. Typically a bond by a state power company could be guaranteed by the state, for instance.
Why is there a yield range for CP’s and CD’s?
Sometimes I can buy an issue at 5.5 (part of the issue) and another part could be subscribed by you at 5.6%. That is why the yield range exists in the reporting.
Is not the yield of ZCB based on price ?
ZCB = Zero Coupon Bond.
It’s based on price and time to maturity. There is no coupon, by definition.
When interest rates rise, why will anyone buy bonds with a lower coupon than what’s available in market today with new coupon rate benchmarked to current interest rate?
They will pay a lower price for the same bond. The answer to why people will buy bonds with a lower coupon rate is that they will pay a lower price for it, and thus the yield will increase. Take a bond that pays Rs. 8 (coupon) for every Rs. 100 face value. Now assume someone sold it to you for Rs. 80 instead. That’s a 10% yield on such a bond.
What is the difference between average maturity and Duration of a MF scheme?
The idea of maturity is the term at which the underlying bonds will mature, weighted by the amount invested in each.
The duration is a calculation of how much the bonds will be impacted by a change in yield. A long maturity bond with a floating rate is not as sensitive to an interest rate change (yield change) as a long maturity bond with a fixed rate.
Some debt mutual funds have -ve cash holding. What does it mean and what are the implications?
Essentially, the fund has borrowed money from banks or such, to pay for redemptions or temporary mismatches in liquidity.
Overnight funds: 1 day duration. I do not understand who is that who just borrows money for 1 day? What’s the purpose?
It’s useful for parking money overnight that may be needed the next day. Typically, a borrower may be a bank that needs overnight liquidity to place with RBI (for CRR Or such) which may be rolled over the next day but with a different amount.
What is a roll down maturity in a MF scheme?
Typically done in Fixed Maturity Plans, the fund only buys bonds that mature before the end of the FMP and then holds them to maturity. This sounds simple but it essentially means you don’t buy beyond the maturity of the scheme.
Any funds that claim to roll down and are open ended (don’t have a maturity date) are to be careful about, since that is technically impossible to keep it rolled down forever.
In all of these funds where a certain percentage is allocated towards the particular fund eg. Gilt 80% government. Where can the balance 20% be allocated?
Anywhere, but typically in debt instruments only. (I.e. not gold or equity or such) Read the offer documents carefully. Balance 20% can into Corporate Debt for Banking and PSU Funds
How do GDP growth and fiscal deficit affect the bond/debt market?
Simply put, if the fiscal deficit increases, the government requirement of borrowing increases. Meaning they will issue more government bonds. More supply = lower price = higher yield. Since govt bonds are super-secure, it means that other private bonds will have to offer even higher yields to compete. Which then means higher interest rates and lower prices of bonds.
Which is the website for the latest TER for all the funds? Value Research? Not sure if it has the latest data?
Amfiindia.com has the data on the TER for each fund house.
Gilt funds typically have high durations?
Seems to be – but this will change over time I suppose. Liquidity is only in the 5 year or 10 year usually.
Any source where rating downgraded are tracked on live basis across all issues. Like we can get a prompt of a downgrade to ensure we have it captured in screener or so?
Screener.in has the data, but we don’t get that on subsidiaries for instance. Only sources for downgrades may be paid tools like Bloomberg, or Reuters.
On “Risky” vs “Non-Risky” Bonds
Do you prefer all the three profiles – conservative, medium and aggressive to be invested across categories (even the riskier ones) or you prefer selective categories according to risk profile? In continuation – prefer same weightages of categories for all profiles?
Not sure what “categories” mean, but I assume you meant something like: If you’re conservative, what should you buy? Liquid only?
The problem is that people are often unaware of what they are, and they change. They are conservative when there is risk. They are aggressive when everyone is making money.
Should you invest in say a credit risk fund, versus only liquids? The answer to that is: only if you understand the risk. If you don’t know what it is to understand the risk, don’t do it. If you don’t have time to spend every month to see what’s happening, don’t do it.
Also, there are no “balanced” people. Everyone is either aggressive or conservative, at any point in time. Some people on average are balanced, but that means they are conservative as many times as they are aggressive.
Some rules will apply to most people (why be aggressive in debt, when you can be in equity?).
Which “instruments” are riskier – ZCB, ABS, MBS, PTCs ? Or can you explain them differently from their theoretical definition?
We won’t go into details here. But we’ve explained ZCBs in the class. Currently ABS/MBS/PTCs – we have a long premium post on it at:
https://premium.capitalmind.in/2018/10/fundas-securitization-the-growth-vehicle-for-nbfcs/
In Gilt, they invest in SDLs – are they risky even with a sovereign guarantee?
Everything has some level of risk or the other. There is the interest rate risk, where if RBI increases rates, we could see prices of bonds fall (higher interest rates=lower bond prices)
Then there’s market and liquidity risk. You may see some bond lose focus in the market, and the market price of your gilt fund’s bonds may be lower than an equivalent price of another similar bond. This happens all the time as the most liquid bond is the 10 year bond, but every few months the actual 10 year bond will be a different instrument, and the older one will have a lower price than the newer one.
There’s a notion many people have that if you enter at a certain average maturity in a debt fund and you hold it till that maturity you’ll get YTM except there is any default. I disagree, the interest rate risk can cause loss or lesser return on the day you exit as these are open ended funds and are MTM
This is not true, because rates change and the fund will add on different securities after you buy that will change both the average maturity and the YTM.
The only way you will get that exactly is: If your fund holds securities of EXACTLY that maturity (all expire roughly at the same time) and after you buy, no one else buys or sells that fund so no money coming in or going. And market interest rates remain exactly the same so reinvestment of coupons can be made at the same yield. This is mostly impossible, so any situation where it has actually happened is pure luck.
FT CEO made a statement on anything below AAA in India not being safe. Could you elaborate further ?
India has very loose definitions of what is AAA, so nearly everything gets a AAA. Which means that if gets a lower rating, it may actually not even be safe enough to meet the very lax criteria.
However we believe that rating agencies are wrong and don’t really know much. See our podcast: https://premium.capitalmind.in/2020/06/podcast-28-why-credit-rating-agencies-are-irrelevant-and-deserve-a-downgrade/
Any bond (apart from govt bonds which sov) can they deny paying the investors capital (apart from AT1 bonds do any other bonds have no obligation to pay back capital )
A denial like this means that they have defaulted on the debt and you can take them to the IBC (Bankruptcy court) and have them sell their assets and recover your (and other debt owners’) money.
Even Gilt fund invest in GOI securities, still the risk is moderate as mention in Value Research?
VR ratings are based on their opinion. These may not be reliable or useful. Having said that there is risk in interest rate movements even in GOI securities.
A rating agency has rated a paper in US as AAA and the same rating agency has rated a paper in India AAA. Is it one and the same or different?
Different. Please read the country specific rating guidelines for the above.
Also, please hear our podcast on Credit Rating Agencies and why they should not be trusted.
On the RBI and Sovereign Bonds
GOI floating rate bonds are linked to inflation?
No, they will be linked with either a T-Bill auction rate or a repo rate or such.
Does rbi follow the dutch auction mechanism?
Not really, it’s not reverse dutch. It’s a simple price based auction.
Why 2031 g-secs was at discount while all others were at premium?
Discount happens if yield is greater than the coupon. A 8% coupon bonds at 9% yield will be at a discount. Simply put, if the yield goes up, the price comes down. If the yield is greater than a coupon, the bond will trade at a discount to the face value.
Take two bonds with the same term to maturity. One is at a 7% coupon, and one is at 9%. If the market yield for each of them is 8%, then the first one will trade at a discount (less than Rs. 100, in industry standards) and the second at a premium (more than Rs. 100).
Hey, we hit a low in 10 Yr G Secs, about 5.9%. Instead of buying now, can we wait for the cycle to turn and hit peak 8% yields? And hold till maturity?
This depends on your assessment of the yield movement. In a mutual fund there is no concept of holding till maturity unless you buy an FMP which only buys such gilt funds.
RBI doesn’t buy bonds directly. However, they also do regular operations for Govt bonds. How exactly does this work? what impact is has on the overall interest rate regime
This is something called an OMO (Open Market Operation). RBI will either:
- Announce an OMO Auction to buy (or sell) Government bonds. Banks and other participants can bid in the auction and RBI will buy in an auction efficient way.
- Regularly buy or sell from other players in the bond markets. There’s a software called E-Kuber where all trades happen, and RBI can be a participant when it likes.
Impact: Typically the idea is to add liquidity to the system, not to impact interest rates.
There are other repo and reverse repo operations that involve a temporary transfer of government bonds between banks and the RBI but that is different from what I’ve described above.
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