Debt Crisis

In continuations to our earlier blog – “Converting Structural problem into cyclical problem” (March – 2013)

As we speak MF Industry is under tremendous pressure with its position in debt market. We have built our largest book of more than 1 Lac crores in long bonds. Our exposure to corporate debt is highest in recent past. Markets have become illiquid with yield spikes. Yield curve has shifted upward by more than 100 BPS on long duration and more than 200 BPS on short duration. Yield curve is once again inverting. Ominous signs for economy. We are staring at sharp decline in economic activity.

It was a black swan event triggered by RBI move to make money expensive in this country. We have been running real interest rate negative for last 3 years. This has built huge speculative activity. People are leveraging and buying house, Gold and spending as value of money is sharply declining. At the same time people at large are speculating in currency, commodities and Bonds. After a long time Reserve Bank has come forward and made real interest rate positive.

Effect of Positive real interest rate

•  Cost of money will go up
•  Will provide incentive to saver and hence capital formation in this country
•  Speculative activities will come down
• It will also channelize money in more productive investments. It may have big impact on residential real estate. Demand may come off sharply.

Our Recommendations

• Investors will have to digest extreme volatility in the market
• Stay away from funds investing in private corporates specially in shorter durations (Accrual Product). Sharp decline in economic activity will increase demand for money by corporates to manage working capital cycle.

We would advise clients to create buckets for different time frame investments and invest in very high quality assets.

Time Frame	Product
Less than one year	Arbitrage Funds / Liquid & Liquid Plus
One Year to 2.5 Years	Bank Debt Funds. Industry at large is expected to launch Bank CD FMP this will create huge demand for Bank CD’s. We would advise clients to build position in advance. Money is expected to move out of short term and duration products. Which will reduce demand for corporate paper at the same time working capital will ensure supply of corporate papers.
More than 2.5 Years	Long term Gilt Funds. This is most liquid part of the market. Idle for FII’s to move in and move out. Crisis in debt market will ensure that more and more people will move towards Bank FD’s. Due to scare of NPA’s banks will find more comfortable to invest in G-Sec. Yield curve is inverted and may remain for some time.

Warning

1.      Avoid Short term funds

2.      Be cautious of underlying securities in debt funds

3.      Avoid Accrual products

4.      Match your investment horizon with very safe and liquid asset class

5.      Smart investors always tend to prefer higher quality asset

We would urge investors to show lot of calm and open mind to new ideas.