AT1 bonds contractually don’t have any reimbursement date, however issuing banks redeem them on the finish of 5 years, as per market apply, although this “gentleman’s settlement” (unacceptable to the regulator!) has been damaged at instances. How these bonds are valued is a little bit of a thriller, particularly within the absence of a deep bond market in India. In now forcing mutual funds to worth them as 100-year devices from 2023, implying a possible deep erosion of their valuation, SEBI has dealt a close to deadly blow to this essential instrument which helps banks meet capital adequacy requirement and permits mutual funds and others to earn return over a 5-year interval. Maybe SEBI’s transfer has been triggered by the nightmarish expertise of buyers in Sure Financial institution AT1 bonds during which they misplaced their complete investment of Rs 8415 crores.
Storm clouds gathering for debt mutual fund buyers
Even earlier than the newest AT1 bond valuation storm, buyers in debt mutual funds had been caught within the proverbial “between the satan and the deep sea” situation. Rising rates of interest had been exposing their lengthy and medium period fund investments to deep capital losses. On the similar time, low period funds had been offering paltry returns of 3-4%, lower than the prevailing inflation charge.
Low period funds ought to profit to an extent, from rising rate of interest tendencies. However with RBI persevering with to maintain the short-term liquidity situation in huge surplus to counter the impression of the pandemic, the low period funds haven’t seen a big uptick in yields.
What can buyers do?
Many schemes from excessive profile fund homes within the Banking and PSU debt fund class, thought of comparatively protected, have publicity to AT1 bonds. With an unsure outlook on AT1 bond valuation, buyers can keep away from mutual funds invested in these devices for now.
Another that buyers can think about is the Company Bond Fund class. Most mutual funds have an providing on this house. Buyers ought to think about credit score danger and period danger whereas selecting the suitable Company Bond Fund. From a credit score danger perspective, SBI, DSP and IDFC mutual funds have a fairly clear portfolio on this class.
Not all Banking and PSU debt funds have publicity to AT1 bonds. IDFC, DSP and Axis mutual funds’ providing on this house have nil publicity to AT1 bonds.
Nevertheless, given the poor expertise with many debt mutual funds within the final couple of years, buyers ought to periodically examine the portfolio of their debt mutual funds and exit them, if they aren’t comfy with the fund managers’ credit score danger calls, submit funding. “Mutual fund investments are topic to market danger” is actually not a cliché with debt mutual funds lurching from disaster to disaster from the Franklin soften all the way down to the newest AT1 bond valuation problem.
Greater the period, increased the danger of capital losses, in a rising rate of interest situation. Together with the portfolio composition, the period of the fund is disclosed within the web site of mutual funds as a part of the month-to-month factsheets. DSP company bond fund has a low modified period of 0.96 years, with a yield to maturity of 4.05%, after bills, within the direct scheme. However the corresponding figures for SBI company bond fund are 2.09 years and 4.9%; for IDFC company bond fund, 2.57 years and 5.29%. To mitigate period danger/potential capital losses in each these funds, buyers can think about making staggered funding, just like a SIP in fairness mutual funds. Within the interim, buyers can park their surplus funds if any, in low-risk in a single day funds. Periodically buyers can change from the in a single day fund to the company bond fund, as and when market rates of interest rise.
Past Corporate Bond Funds and Banking/PSU debt funds
To allay investor fears of rising rates of interest and consequent capital losses, IDFC mutual fund has provide you with new choices to handle this problem. IDFC’s gilt index funds have a goal maturity date in 2027/2028, and can make investments solely in authorities securities mitigating credit score danger. Buyers who keep invested until maturity might not face capital losses. There’s a draw back: within the occasion of a pointy enhance in rates of interest over the following yr or so, the funds might face erosion of their worth, with buyers who leap in at the moment getting a greater entry level. Buyers can due to this fact think about staggered funding, akin to an fairness SIP. In in the present day’s rising rate of interest situation, one can anticipate extra such choices from mutual funds. After the current bitter expertise with a worldwide fund home, buyers can keep on with mutual funds backed by giant Indian banks or standalone ones with an impeccable monitor document, even for investments in comparatively protected goal maturity date index funds.
Will the Authorities’s generosity proceed?
No debt mutual fund providing can beat the largesse of the Authorities in providing Floating Charge Financial savings Bonds at enticing rates of interest (at the moment 7.15%, topic to periodic reset). Whereas these bonds don’t supply any tax profit, danger averse particular person buyers who’re cautious of the numerous market danger in each debt mutual fund providing and the fixed drum beat of adverse headlines on this asset class, can think about the Floating Charge Financial savings Bonds out there on faucet, from the Authorities of India. Nevertheless, the current flipflop by the Authorities in chopping the rate of interest by 0.9% after which backtracking in lower than 24 hours, brings a component of uncertainty on the returns of this bond over its 7-year tenor.
The author is a hard and fast revenue investor and erstwhile company banker.