)
The financial stress on companies and the likelihood of more downgrades could start taking a toll on the credit quality of bond funds. Investors in bond funds should opt for funds that have more of the highest-rated debt paper, experts say.
In the last financial year, profits of companies fell significantly; the case was similar in the first quarter of this financial year. R Sivakumar, head (fixed income), Axis MF, says, “There’s substantial deterioration in the financial health of companies and in some cases, it’s even worse than during the 2008 financial crisis.”
Many companies are finding it difficult to make payments on debts, something reflected in the huge non-performing assets (NPAs) of banks. In the quarter ended June, the NPAs of public sector banks rose 16 per cent quarter-on-quarter. A recent CRISIL study said a third of the companies it rated didn’t generate sufficient cash to service their debt through internal accruals.
Amid all this, the quality of debt holding has become a major concern. Lower-rated corporate bonds are at a significantly higher risk and are more prone to downgrades in the near future. Often, bonds that are downgraded see a spike in yields and erosion in values; funds that hold such bonds take a huge hit on their net asset values. Sivakumar says, “The downgrade risk is overwhelming, and once you have a downgrade at this juncture, bond values decrease.”
Also, investors are not compensated for the higher risk they take in lower-rated bonds. Now, the spread between the AAA-rated paper and the AA-rated one is about just 50 basis points, significantly lower than a few years earlier. Yadnesh Chavan, fund manager (fixed income), Mirae MF, says, “The incremental returns on lower-rated paper are minimal, and it’s not worth taking that risk in this environment.”
If credit quality goes haywire, only bond funds that have a high percentage of their corpus invested in the AAA-rated paper might be able to withstand the pressure on the debt market in the coming months.
Last month, debt funds lost 2.4 per cent, while short-term bond funds lost 1.2 per cent, as the rise in yields sent bond prices lower, owing to a sell-off by foreign institutional investors in the bond market. According to Value Research, long-term gilt funds were the worst hit, with loses averaging 3.1 per cent.
In the last financial year, profits of companies fell significantly; the case was similar in the first quarter of this financial year. R Sivakumar, head (fixed income), Axis MF, says, “There’s substantial deterioration in the financial health of companies and in some cases, it’s even worse than during the 2008 financial crisis.”
Many companies are finding it difficult to make payments on debts, something reflected in the huge non-performing assets (NPAs) of banks. In the quarter ended June, the NPAs of public sector banks rose 16 per cent quarter-on-quarter. A recent CRISIL study said a third of the companies it rated didn’t generate sufficient cash to service their debt through internal accruals.
Amid all this, the quality of debt holding has become a major concern. Lower-rated corporate bonds are at a significantly higher risk and are more prone to downgrades in the near future. Often, bonds that are downgraded see a spike in yields and erosion in values; funds that hold such bonds take a huge hit on their net asset values. Sivakumar says, “The downgrade risk is overwhelming, and once you have a downgrade at this juncture, bond values decrease.”
Also, investors are not compensated for the higher risk they take in lower-rated bonds. Now, the spread between the AAA-rated paper and the AA-rated one is about just 50 basis points, significantly lower than a few years earlier. Yadnesh Chavan, fund manager (fixed income), Mirae MF, says, “The incremental returns on lower-rated paper are minimal, and it’s not worth taking that risk in this environment.”
If credit quality goes haywire, only bond funds that have a high percentage of their corpus invested in the AAA-rated paper might be able to withstand the pressure on the debt market in the coming months.
Last month, debt funds lost 2.4 per cent, while short-term bond funds lost 1.2 per cent, as the rise in yields sent bond prices lower, owing to a sell-off by foreign institutional investors in the bond market. According to Value Research, long-term gilt funds were the worst hit, with loses averaging 3.1 per cent.
