R Sivakumar's advice for the debt investor

Oct 21, 2022

At the recent Morningstar Investment Conference India, R Sivakumar, head of fixed income at Axis Mutual Fund, was one of the panelists.

Here are some excerpts from the conversation.

We are a much younger set as compared to our equity brethren. But it doesn't mean that we can't learn the lessons that they have learned or implement much the same way.

Equity investors would have lost money in badla. In the 1994 IPO boom. The NBFC crisis of late 90s. The 2008 GFC.

In 2000, diversified equity funds used to have 60% to 70% in infotech stocks. Then the dotcom crash happened. In 2007 and 2008, equity funds were much more diversified and were not as concentrated as they were in 2000. The lessons learnt of the previous cycle really helped, even though the overall large-cap market fell by 50% and mid-cap fell 75%. Yes, mutual funds all fell, but they didn't fall like the way they fell in 2000, 2001, 2002.

These lessons are also being learned on the fixed income side. Volatility exists. In 2013, the RBI raised rates by 300 basis points in one shot. In 2018, we had a credit event. In 2020, we had a liquidity event. We learn from these events and how to manage it, both from the industry perspective and investor perspective. Looking back, 2020 was the best time to buy credit. Looking back, in 2013, 10-years G-Sec went above 9.25%. We have not seen that level come back again. That was a buying opportunity of a decade.

When COVID happened, the equity market tanked. SIPs continued. Inflows picked up in equities. Because investors, having seen the past, figured out that when you have a crisis of this sort, you buy more. The same thing will happen in debt over a period of time.

The first time a credit event hits, you don't know how to react. The second time it hits, we know how to manage this.  That's the nature of development.

When an event happens, it is magnified. But we learn and move on. We evolve and we grow. 

Could 2018 have been avoided? Yes and no.

Could ILFS have been avoided? No.

Could we have probably stopped it from becoming a wider crisis? Possibly, yes.

ILFS was a systemically important financial institutions, meaning that it featured on a list maintained by RBI that looks at entities which can create systemic crisis if they default. So, they knew that an ILFS default can become systemic crisis. Could they have done something to stop it becoming messier? Maybe. But the reality is that many companies were overleveraged and we were in the down leg of an economic cycle, which is typically when credits start underperforming. So, to that extent it was not completely avoidable, I think it could have been managed maybe slightly better.

Over the last one or two years, credits were probably the best performing subsegment of the bond market. Even on a 3-year, 4-year, 5-year basis, which means that the period includes 2018 and 2019. Credit has done remarkably well, especially on the mutual fund side. At that point of time it looked like a major stress and a major credit event. But even the largest credit player who was forced to shut certain schemes two years ago eventually ended up repaying all or most of the money. The stress was much less than what we had feared.

Today, things are very different. Companies are much less leveraged. In fact, the challenge is actually on the other side. We're not seeing enough issuance and yields are much lower than what we would have liked. So, I think it is a very interesting opportunity, certainly not the kind of risk that we saw four years ago.

My message to all investors is simple: Don't forget asset allocation.

The mistake many investors did in 2007 after seeing a massive rise in equities, was to go significantly overweight. The market turned and their portfolios were a mess.

Much the same way, it has not been a great period for debt and equities have done really, really well. Don't let portfolios get unbalanced. Make sure that you have an asset allocation across equities and fixed income and within fixed income also run a balanced strategy. Don't go only by the flavour of the season.

That comes first. Which fund to buy, which strategy etc is secondary. You will get a good outcome by ensuring that your portfolio is reasonably diversified. Have an asset allocation plan and stick to it.

On investors directly investing in a corporate bond issue.

The retail investor is free to buy options. Free to buy small-cap stocks. We trust investors to evaluate their risk and buy. They can buy with full knowledge that they are buying a high-yield instrument.

Having said that, it still makes enormous sense for most investors to buy bond funds rather than invest in bonds. I think it is the easiest way. For example, if you diversify your portfolio across 1,100 mid-cap stocks, even if a few go bust, nothing happens to your portfolio. Same with bonds. You buy 100 bonds and one or two go bust, nothing will happen to your portfolio.

Credit research and fund management are both important.

Fund management starts with research. We do our research and credit analysis. Yes, we can outsource data and views from rating agencies. But we do not invest based on data alone. We do the work. The credit analysis. The research. We need to know the companies that we are investing into. Then we decide whether to invest or not. To that extent, credit investing is no different from equity investing.

Then begins the hard part. How much should I buy? How much of the portfolio must be allocated to it? What maturity should I buy? What kind of covenants or structures should we create? All of that comes to make sure that you manage credit risk, liquidity, and diversification.

It is also tax efficient. Long-term capital gains for debt are realised after a 3-year holding period. Now if you stay for 3 or years in a fund, one interest rate cycle has gone by. Hence, the chances of people losing money in a debt fund are very low and chances of seeing a decent outcome are very high. As long as you stay for a reasonable period of time, the outcome is good.

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ninan joseph
Oct 31 2022 03:30 PM
Just to take the point forward,
What these guys are trying to sell is

An equity shareholder is asked to stay on the 15th floor of a building.
A bond holder will be assigned the ground floor of the SAME BUILDING.

When an earthquake or the building is stuck with fire, the equity guy will vanish but the bond holder is told, that you have the possibility of running away when you feel the shake....

Poor investor feels the man selling the case is a professional and invest money without realising that the money parked in equity and debt is the same market.

Wonder if DHFL bond holders got anything......At the same time, Yes Bank depositors were protected.......
ninan joseph
Oct 31 2022 03:22 PM
Hence, the chances of people losing money in a debt fund are very low and chances of seeing a decent outcome are very high.

Confused and flummoxed.
Primary purpose of people investing in debt - to have their capital protected. How come it is ok, to invest in a debt fund of 100 companies (say) and take it on your chin if two or three fail.
Why. Do not understand who has drawn the line that one or two companies failing is ok in debt fund.
Does the AMC, take any responsibility if one or two of the corporate fail or will the AMC, not charge commission if one of the corporate within a fund fail.

I can understand in case of equity, the gain is unlimited and the loss is upto the invested amount. Hence we pay AMC commission to identify Cos as we have been repeatedly told that AMC managers are professionals. (Cant forget Franklin Templeton case).

How is the same logic being applied to debt fund. What is the role of the AMC.

The entire debt fund is a fiasco. It is like this
A invest in ABC company share directly.
B invest in ABC bond.
C invest in debt mutual fund where ABC is a participant.

Now if ABC goes bad, the equity shareholder gets hit for sure, but even the bond holder will get hit the same way as ABC will not have cashflow to pay.
So how in heaven's name do these guys come and keep preaching about debt fund. if this is the risk, I will rather invest in a equity mutual fund who have invested in ABC and hope it becomes a multibagger.

If you are talking about debt fund, the underlying should be totally different from the market, this will ensure that if equity market falls which means, ABC falls, my debt fund if the underlying is something separate will remain intact such as GSEC, or FD.
These guys come out preaching about taxation. Tax is only paid on the net income if I put my money in FD, but with debt fund, I should reconcile that one or two corporate will fail when in fact nothing should fail.
Whose money is it anyway........Sad.....
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