Sudden spike in bond yield amid coronavirus outbreak signals trouble

Also, watch out for a company raising money at a very high rate of interest

With the lockdown affecting cash flows across sectors, companies are getting downgraded at a rapid pace. Hence, the risk that they may have difficulty in servicing their debt obligations in the future is rising. Retail investors, who invest in non-convertible debentures (NCDs), corporate fixed deposits (FDs), debt mutual funds and hybrid funds need to be cautious in this environment.  

Credit-quality pressures were building up already, and the pandemic made matters worse. “Even in the quarters prior to the lockdown, there were clear signs that growth would slow down. Even in FY20, the number of downgrades was much higher than the number of upgrades. Over the past two-and-a-half months, a large number of entities across a wide range of sectors have faced demand pressure. As a result, credit quality, leverage and debt coverage-related metrics have all been coming down,” says Jitin Makkar, head-credit rating policy, ICRA.

Rating agencies have been reassessing ratings more frequently to reflect current conditions. “The number of reviews has gone up, and so has the number of downgrades and outlook changes,” says T N Arun Kumar, chief ratings officer, CARE Ratings. Between April 1 and May 18, 2020, CARE Ratings downgraded 164 companies in investment grade. Of the 538 companies (in investment grade) whose ratings were retained, the outlook was revised downward for 146.

Investors need to monitor their bond holdings closely in times like these. “A sharp fall in prices or a spike in yields can be a sign of trouble. If a company whose bonds you own does a primary issuance at a very high rate of interest, that is another red flag,” says Deepesh Raghaw, founder, PersonalFinancePlan.in, a Sebi-registered investment advisor. Yields of bonds that trade can be obtained from the exchanges. Off-exchange transactions have to reported to the Clearing Corporation of India. The weighted average yield for the day’s transactions can be obtained at its website (ftrac.co.in). A downgrade by a rating agency is yet another warning sign.

 

 

Look closely at the bonds rated below AA+ in your portfolio. “Factor in the rating but also look at the company. I would worry less about AA-rated bonds from a bank and more about such bonds from an NBFC. I would also worry less about, say, bonds of Bharti Airtel having this rating than if they belong to a lesser-known company,” says Raghaw.

Government-backed bonds are the safest. “If you have invested in a PSU bond, or in a bond from a top-rung corporate whose papers are liquid, you should be safe,” says Rajesh Cheruvu, chief investment officer, Validus Wealth.

As for debt funds, stick to the safest of categories. “If you are investing for more than three years, go with a banking and PSU fund or the Bharat Bond Exchange Traded Fund. If you are allocating for less than three years, stick to an overnight fund for the next two months,” says Cheruvu.

Risk could be lurking in the debt portion of equity-oriented hybrid funds as well. Fund houses are carrying out inter-scheme transfers of bonds from credit-risk funds to hybrid funds, which could raise risk in the latter. “Structured obligations are present in the portfolios of hybrid funds. They have very little liquidity,” adds Cheruvu.

If you hold bonds, directly or indirectly, that make you uncomfortable, exit now. You can exit a corporate FD or a debt fund anytime. While you can sell NCDs on the exchanges, you may not get a good price there. Some NCDs and other bonds also trade in the over-the-counter (OTC) market and debt market brokers may be able to help you sell them there. Finally, be on the lookout for offers by issuers to buy their bonds back.