How India and US bond markets are moving and lessons for investors

Article published on Moneycontrol on 6 July 2017. Please click here for the link

To make sense of the ‘conundrum’, there is one common factor driving markets: liquidity.

Joydeep Sen

As a thumb rule, when the economy is expected to grow at a brisk pace, equity prices move up and bond yields move up as well, since demand for money would be more, thereby pushing up interest rates. Similarly, when the economy is sagging, bond yields come down as demand for money is that much lower and interest rates ease accordingly. However, the current developments in both US and Indian markets defy this convention. Let us look at the market movements.

In the US, there was a ‘preparation phase’ for a long time, on the exit from exceptionally low interest rates that was administered in the wake of the Global Financial Crisis (GFC). The ‘exit’ started with the tapering and eventual withdrawal of the bond buyback programme of USD 85 billion per month, which was meant to inject liquidity into the system. Finally, from December 2015, the US Fed FOMC started raising signal interest rates. The overnight rate, which was 0 percent to 0.25 percent at that point of time, was raised by 25 bps to 0.25 percent to 0.5 percent in December 2015. Till date, they have raised rates by 1 percent, bringing the overnight rate to 1 percent to 1.25 percent. It is expected that the US Fed will continue hiking rates, rather normalising it because they are exiting from exceptionally low rates, at an appropriate pace over the next couple of years. As per the Staff Economic Projections (SEP) of the US Fed, popularly known as the dot plot, the terminal rate at the end of the rate normalization cycle is expected to be somewhere around 3 percent.

In this situation, what do you expect? You would expect the US Treasury yield to move up, right? Now listen to this: US Treasury yield is lower now, than in December 2015 prior to the initiation of the rate hike cycle. US Treasury 10-year yield is at 2.16 percent now (26 June closing), lower than 2.2 percent-2.25 percent in December 2015. Puzzling? Former Fed chairman Alan Greenspan used a term ‘conundrum’ for this kind of situation, which cannot be explained by conventional logic. US equity markets are booming, Dow Jones is at 21,409 now and S&P 500 is at 2,439 (26 June closing). The market does not expect the economy to slow down, which may have required the US Fed to slow down rate normalization. That is to say, given the buoyancy in the equity market, the US economy is not expected to sag. The US Fed is expected to continue rate hikes at a pace appropriate for them, but the US bond market is ignoring that aspect.

Now shift to India. Situation is somewhat comparable: equity market is booming, Nifty being at 9511 and Sensex at 30958 (27 June closing), and bond yields are easing, 10-year (new) benchmark being at 6.46 percent (27 June closing). There is an apparent dichotomy; if the economy is expected to do well, the RBI may not need to cut rates to give interest rate boost to the economy, and if the economy is not as buoyant, the equity market is probably going for a PE re-rating. However, there is one fundamental difference between the developments in US and India: the RBI eased rates over the last 2.5 years and there is possibility of further policy rate cut to a limited extent. Hence, there is logic for bond yields to be on the lower side in India.

To make sense of the ‘conundrum’, there is one common factor driving markets: liquidity. Though it is not the leveraged liquidity that led to the GFC, there is enough money globally chasing assets. Any positive indication in an asset class is taken as significantly positive, e.g. equity market upside, and any relative valuation is that much more attractive e.g. US bond yield levels over Euro-zone yield levels or India G-Sec or corporate bond yield levels over emerging markets.

Message for investors: In the Indian context, stick to the asset allocation that suits your risk-return profile and horizon, you need not be unduly bothered about market levels. For equity investments, leave it to professional fund managers for picking the stocks that would benefit from the India growth story. We are the fastest growing major economy in the world, and whatever little deceleration in growth happened in the quarter Jan-Mar’17, due to demonetization or other reasons, is expected to be transient. In the bond market, inflation is undershooting expectations, even RBI’s own projections, which will keep the market supported. If you are not comfortable with volatility in your fixed income portfolio, allocate to short maturity bond funds rather than long bonds. India has a much better fundamental logic for investments than USA, driven by economic growth and easy monetary policy support.

(The writer is an independent financial advisor)

Why distributors should not rely on MF ranking agencies

Article published on Cafemutual on 10 July 2017. Please click here for the link

Go for a fund house with a good track record across market cycles, large size and with skin in the game

In the fine print of the consultation paper on RIAs, SEBI has proposed to regulate mutual fund rankings to bring uniformity and transparency across ranking agencies.

Let us start with the initial statements of SEBI on regulating such agencies. “It is simply a statistical sorting of similar peer group mutual fund schemes based on their past performances, risk and return analysis, etc. and is not an opinion on the future performance of the scheme/portfolio.” While in a way it sounds obvious, investors need to understand that it is a statistical sorting and the top rated funds are not necessarily the best funds. Simply put, these funds have performed better than others only in terms of certain parameters.


Take the next observation from SEBI: “Since ranking of mutual fund schemes is an objective statistical analysis of various parameters like risk and return, liquidity, performance ratio, etc. for past years, it appears to be more of a research work that serves as the basis for investment decision by the investors.” SEBI clarified that ranking is just a documented method to find out the past performers and not the subjective opinion of the ranking agencies.


The analysis is historical but for you, it is about the fund performance in a future period. Let us draw an analogy from cricket. If you are selecting a team on the basis of past performance, you would select batsmen like Sachin Tendulkar or Virat Kohli for top ranking. However, the best performer in the next match or series of matches could be some other batsman. It could be a proven player like Shikhar Dhawan or it could be a surprise like Karun Nayar.


There is another element of subjectivity in the analysis. Even an objective parameter like returns can be looked at from various perspectives. Let us look at the basic aspect of returns, without complicating it with things like risk-adjusted returns and statistical ratios. Returns may be measured as (a) simple point to point, i.e., returns till date over last one year, two years, and so on, or it could be (b) rolling returns.


These computation methods may throw up different winners for the same historical period. The point is that these outcomes can be used for your decision-making but only as one of the criteria, not the sole criterion.


This brings us to the core of the issue: what should be your criteria for choosing funds? It should start with the ‘hygiene factors’, i.e., even before you come to performance, it should satisfy certain basic criteria set by you. It could be the reputation and size of the AMC/sponsor, the stake in the business (it indicates importance of the mutual fund business to the business group) or it could even be the service level experience of the past.


After hygiene factors comes the investment objective of your clients. It could be to take advantage of India’s growth story, to benefit from small cap winners, to benefit from interest rates coming down from long bond funds or just earn steady returns in a rising interest rate scenario.


You have to identify funds that have good track record across market cycles. This is similar to the concept of ‘horses for courses’. Taking the analogy of cricket once again, selectors choose batsman Cheteswar Pujara for test cricket but not for one day or T20 cricket, due to his specialised skillsets. Choose funds that have performed better in the past, but you need not necessarily go in the order of ranking given by the ranking agency.


To conclude, SEBI proposes that the “activity of ranking of MF schemes shall be brought under the regulatory ambit of SEBI (Research Analysts) Regulations, 2014” and “over time, it may be appropriate to relax strict limitations on advertising that prohibit the use of third party non-compensated fund rankings or other information that is not false or misleading”. As and when that happens, you can fall back upon it, but remember to use it in the manner discussed here.


Joydeep Sen is Independent Bond Market Analyst and Author.





Relative valuation of equity and debt: What the market is telling you

Article published on Moneycontrol on 20 July 2017. Please click here for the link

Markets have run up in anticipation. In the bond market, there is expectation of rate cut by the RBI in view of soft inflation.

Joydeep Sen

At the current juncture, both the market segments i.e. equity and debt, look a little stretched. In equity market, it is the valuation as represented by the conventional parameter of PE ratio, denoting the number of years for which the buyer is paying for one year’s earnings of the company. In debt, it is the yield level of the bond. The reason why valuation looks little stretched have already been discussed in various forums.

Just to recap: the PE ratio (at approx 25) is high as per historical standards, which means Nifty stocks are not cheap to buy. Coming to bonds, the yield on the 10-year government security is at approximately 6.45 percent and the overnight interest rate, represented by the RBI repo rate, is at 6.25 percent. It means there is a spread of only 20 basis points between overnight and 10-years. As per the theory of time value of money, I should get compensated for sparing for a long period of 10 years instead of just one day. Though there is no formula to define what should be the ideal spread for time value of money, approx 20 bps for 10 years looks inadequate.

So, what is happening? Markets have run up in anticipation. In the bond market, there is expectation of a rate cut by the RBI in view of soft inflation. From that perspective, bond valuation is not as stretched. RBI’s projection of CPI inflation is 2.5 percent to 3.5 percent in the first half of the financial year and 3.5 percent to 4.5 percent in the second half. Taking inflation at a ballpark of 4 percent, which is RBI’s central target in the zone of 4 percent +/- 2 percent, and 1-year T-Bill yield being around 6.38 percent, there is significant real positive yield. In the equity market, investors are building in earnings growth pick-up, higher expansion of the economy and probably a PE rerating.

There is a thumb rule to figure out the relative attractiveness between the two markets. The inverse of the 10-year bond yield is compared with the equity PE. Inverse of 6.5 percent is 15.4, which denotes that if the equity PE is at or less than 16, equity is very attractive. Now that equity PE is at approx 25, it is not as cheap. However, as discussed, the equity market may witness a PE rerating driven by lower cost of capital and better earnings growth. Since there is a discounting of future growth in equities, which is not the case with bonds, some premium is justified. However, the current gap between 16 and 25 seems to be on the higher side.

What do the valuations mean for investors? Allocation should be guided by the proven parameters of risk-return profile and horizon. Current market valuation can influence the allocation at the margin but should not be a major criterion as timing the market may not yield much over the long term. In case the equity valuation looks stretched, leave it to managers who have a proven track record of identifying value stocks, and invest with a long horizon. In the fixed income segment, if you are not aiming to benefit from the last rate cut by the RBI, you may go for conservatism and put your money in short-term bond funds instead of long term ones, to minimize volatility as and when it comes. It has been proven that over the long horizon, the outperformance of long bond funds over short term funds is not much. From 2001 till date, cumulative return from income funds is 8.04 percent and that from short term bond funds is 7.73 percent (source Crisil - AMFI Report June ’17) i.e. the outperformance is only 31 basis points.

Another perspective, for deployment of incremental flows of investors, could be alternate avenues like structured products (market-linked debentures), where the downside in case equity markets don’t give returns is protected but the market-linked coupon provides the equity upside. This is suitable for investors who want to participate in the equity market upside but are wary of the downside. However, there is a minimum ticket size required for structured debentures and is available to HNIs, not retail investors. In the mutual fund space, there are certain funds that do the asset allocation as per valuation levels in the market and restructure the portfolio at periodic intervals.

(The writer is an independent financial advisor)

Mutual funds systematic withdrawal plan: From ways to use SWP to benefits; here is what you can profitably learn

Article published in Financial Express on 22 August 2017. Please click here for the link

When the equity market has run up and we are not sure whether to stay invested, SWP may be used for a gradual withdrawal into a defensive asset class and get the benefit of exit cost averaging when the market is on the higher side.


When we withdraw a defined amount every month (or some other interval) from a mutual fund scheme as a standing instruction, it is referred to as systematic withdrawal plan (SWP). In a way it is the reverse of SIP; while investments are done through a systematic investment plan, redemptions are done through SWP. We will discuss here how it can be used by you vis-à-vis lump-sum redemptions.

Regular cash flow

When there is a requirement of a regular cash flow, say a defined amount every month, from a portfolio of MF investments, the common solution is to opt for dividend option in a fund that has a history of monthly pay-out—MIPs, Arbitrage Funds, Short Term Bond Fund, etc. The question arises when the amount of expected dividend does not match the cash flow requirement per month. In such a situation, the solution is to do a SWP.

To be noted, some investors believe that capital should not be used for regular expenses. However, if you require that money for your day-to-day expenses, it was anyway not an investible surplus and there is no issue in withdrawing it for your requirements. To look at it from a different perspective, for the period it was invested, you earned the returns and then withdrew it.

Funding retirement

SWP is typically used by retired people for their cash flow purposes. The estimated amount of expenses per month is put in the form of SWP. The SWP amount per month is consumed and the remaining corpus continues to earn the fund returns, which provides the sustenance for future.

Let us take an example. Let us say a 60-year-old retired gentleman has a corpus of Rs 1 crore in mutual funds and requires Rs 70,000 per month for his expenses. He does an SWP of Rs 70,000 per month. Apparently, at a withdrawal rate of Rs 8.4 lakh per year, his kitty would last for approximately 12 years and he may outlive his savings.


However, the remaining corpus continues to earn and the longevity of his corpus is extended to that extent. Building the cash flows in an Excel, assuming a rate of return of 8% pre-tax and post-tax return of 30%, i.e., net return of 5.6%, the corpus lasts for 20 years. This is conservative; there is tax efficiency in debt funds for a holding period of three years and a holding period of one year for equity funds.

Taking a net return of 7% for the purpose of our illustration, post the tax efficiency, the corpus lasts for 26 years, adequate for the investor in our example. The SWP amount in our example, i.e., Rs 70,000 per month, may be a combination of dividend and SWP. Dividends in Arbitrage Funds are tax-free, hence for the first one year, this may be used for generating tax efficiency. For debt funds like MIP or Short Term Bond, for a holding period of more than three years in the growth option, the amount withdrawn in a year will get indexation benefit.

Building defensive assets

There may be another use of SWP, apart from the post-retirement sustenance discussed above. When a market, typically equity market, has run up and we are not sure whether to stay invested, SWP may be used for a gradual withdrawal into a defensive asset class. Normally, market based triggers are used for this purpose. However, SWP also may be considered for this purpose. If SIP gives you the benefit of cost averaging while entering a fund when the market level is on the lower side, SWP would impart the benefit of exit cost averaging when the market is on the higher side. You may like to re-allocate a part of your portfolio to make it less prone to volatility in a phased manner.

Joydeep Sen
The author is managing partner, Sen & Apte Consulting Services LLP

What you should focus on while deciding your SIP allocation

Article published on Moneycontrol on 7 September 2017. Please click here for the link

The average SIP size is Rs 3,250 and the month-wise collection through SIPs is just under Rs 5,000 crore per month now. It shows investors are walking in the right direction.


Joydeep Sen

You couldn’t have missed the ‘Mutual Funds Sahi Hai’ campaign. While the message in the campaign is true, we will discuss the reasons why, to give you a better perspective. Just to give a data point to start with, the number of systematic investment plan (SIP) accounts are now as high as 1.52 crore and the Mutual Fund industry added more than 8 lakh SIP accounts per month on an average in FY 2017-18. The average SIP size is Rs 3,250 and the month-wise collection through SIPs is just under Rs 5,000 crore per month now. It shows investors are walking in the right direction.

There are multiple reasons why SIP is the right choice, particularly for small to medium investors (SMIs). The foremost reason, though you would have heard it earlier but just to refresh it, is the power of compounding over a long horizon. Let’s say your age is 25, your expected retirement age is 60 (i.e. 35 years of SIP) and the amount of SIP is Rs 3,250 per month. Assuming a rate of return of 10 percent per year in your SIP, after 35 years, your contribution of Rs 3,250 per month would grow to as much as Rs 1.24 crore. Sounds impressive? But if you are late by even five years, the corpus after 30 years (instead of 35 years) would be Rs 74 lakh. And if you are late by five more years i.e. start at age 35, the corpus would be Rs 43 lakh. The advantage of SIP is not only that you are not trying to time the market, it is also about availability of the money to invest. It is conceptually like a recurring deposit; instead of deposits, the money is going into an equity fund.

The queries that crop up most frequently in Moneycontrol Master Your Money (MYM) sessions are about the choice of funds for SIP. It is but natural for investors to be worried about their choice of funds. What needs to be appreciated is that as long as you are walking, you are making progress. Choice of funds is relevant, but all mutual funds are SEBI regulated entities and all are managed by professional fund managers. Nobody knows for sure, not even any expert, that if you are putting your money in five funds, which of these will give how much or which will be the best performer after say 5 years or 10 years. In case somebody could tell that after 10 years fund A will give a return of 14.67% CAGR and fund B will give 13.92% CAGR, he would be God.

The point I am making is, the frequently asked question (FAQ) ‘which is the best fund’ has no clear answer. If we are trying to extrapolate the performance of last 1 year or 5 years for the next 1 or 5 years, it is anybody’s call. Net-net, select fund from AMCs that have a proven track record in managing that kind of fund i.e. large cap / diversified / thematic / small or medium cap as well as the CIO / fund manager having a proven track record. You may spread your money over say 4 or 5 funds, need not diversify too much, as the underlying portfolio of the funds are diversified. You may bet your money with say 5 fund managers, but need not spread it over 10 fund managers.

Rather than ‘which fund is the best’, you need to focus on the following for deciding your SIP allocation:

• If you are putting all your money in equities, you have to have a long horizon. If you are young, say 30 year old, and do not require the money in a hurry, feel free to go ahead.

• If you are not-so-young, say nearing retirement, do not put 100% of your money in equities as it can be volatile, particularly now as the valuations are not very attractive. You should park a part of your money in debt funds. To give you a perspective on volatility with historic data, over the last 38 years, on a 1-year holding period, equity (represented by Sensex) has given positive returns 25 times i.e. the success ratio is 66%. On a 5-year holding period, positive returns have been obtained 31 of 34 times i.e. success ratio improves to 91%. On a 10-year holding period it is 97% and beyond that, over 15 and 20 years, it is 100%.

• You may go direct to mutual funds after doing some basic due diligence. If you are short of time or not sure of how to go about it, you may take advice from an advisor or go through a distributor.

The writer is an independent financial advisor.

Long term capital gains tax on fixed income: How to calculate indexation benefit

A new series of cost inflation index will be applicable from assessment year 2018-19 to calculate indexation for the purpose of long-term capital gains tax

Article published in Financial Express on 11 September 2017. Please click here for the link


Joydeep Sen

In the context of taxation of fixed income mutual funds, it is known that tax efficiency is generated over a holding period of three years. The investment in the growth option of the fund becomes eligible for taxation as long term capital gains (LTCG). The rate of taxation for LTCG is 20%, plus surcharge and cess as applicable, with the benefit of indexation. What needs to be refreshed is that while the principle of LTCG taxation remains same as earlier, there is a new series of cost inflation index (CII) numbers which needs to be taken into account.

Revised CII numbers

The erstwhile series of CII numbers started from 1981-82, which was set at 100 and the numbers for all subsequent years reflect the moves in consumer price inflation. The revised series of CII numbers start from 2001-02 which has been set at 100. The new series of CII numbers is applicable from assessment year 2018-19, i.e., financial year 2017-18. Hence it is useful for investors to be aware of the revised set of numbers, though there is no significant change in the basis of taxation. Now let us look at a couple of illustrations to understand how indexation works.

Illustration 1

You invested in a fixed maturity plan (FMP) on March 26, 2013. It matured on September 4, 2016. Starting NAV was Rs 10, and terminal NAV was Rs 12.5. What is the incidence of LTCG tax? Your year of purchase was 2012-13, when the CII was 200. Year of sale/redemption was 2016-17, when the CII was 264. Hence the purchase cost gets ‘indexed’ to 264/200 X Rs 10 = Rs 13.2. Since the indexed cost is higher than the redemption NAV, there is no tax incidence. In fact, there is a notional loss, which can be adjusted against other long term gains.


Illustration 2

You invested in an FMP on April 17, 2013. It matured on September 4, 2016. Starting NAV was Rs 10, and terminal NAV was Rs 12.5. What is the incidence of LTCG tax?

Your year of purchase was 2013-14, when the CII was 220. Year of sale/redemption was 2016-17, when the CII was 264. Hence the purchase cost gets ‘indexed’ to 264/220 X Rs 10 = Rs 12. The indexed long term capital gain is Rs 12.5 minus Rs 12 = Rs 0.5. Let’s take the LTCG tax rate at 20%, ignoring surcharge and cess for simplicity. The incidence of LTCG tax comes to Rs 0.5 X 20% = Rs 0.1 and the net of tax realization is Rs 12.5 minus Rs 0.1 = Rs 12.4, without considering surcharge and cess.

The inflation benefit given to investors in the new series of CII numbers is similar to the earlier series.

Tax efficiency of LTCG over STCG

Assuming you are in the highest tax bracket, i.e., 30% plus surcharge and cess, LTCG is much better as the tax rate is lower and you get the benefit of indexation. Even if you are in the 20% tax bracket, LTCG is better than STCG by virtue of indexation. The investor being in 5% or lower tax bracket, i.e., income less than Rs 5 lakh per year is an exception.

The author is managing partner, Sen & Apte Consulting Services LLP

Mutual funds: What should investors in dynamic bond funds do? Find out the way forward

Article published in Financial Express on 27 September 2017. Please click here for the link


There is a case for some further policy rate easing in the Oct 4 RBI Policy review, driven by real positive interest rates, inflation being within target and GDP growth being sub-optimal. As and when the interest rate cycle turns, which is some time from now, existing investors may take a switch call


Joydeep Sen

Dynamic bond funds are ones that maintain portfolio maturity ideally on the longer side, but modulate the maturity profile as per the view on interest rate movements. That is to say, on a bullish view on interest rate movement, the fund manager would increase portfolio maturity to say 15 years to take advantage of fall in interest rates. On the other hand, when the view turns bearish and interest rates are expected to move up, the fund manager would turn defensive. He would reduce the portfolio maturity to, say, six years to minimise the adverse impact of interest rates moving up. These funds normally do not take credit risks, i.e., exposure to less-than-AAA rated securities and the dynamism is about varying the portfolio maturity to benefit from interest rate movements. The portfolio may include some government securities, which is the best credit quality available. The reason for taking exposure to G-Secs is that these are more liquid than corporate bonds and help build longer duration in the portfolio.

Invest and forget

In a way, dynamic bond funds are invest-and-forget products because the fund manager is there to take portfolio positions as per the view on interest rate movement. However, to an extent, the investor needs to track what’s happening around him and take decisions on allocation to fund categories. A short-term bond fund would have a lower portfolio maturity than a dynamic bond fund as per the mandate / positioning of the fund, and in that sense is more defensive than a dynamic bond fund.

As and when the interest rate cycle seems to be turning around from bullish (i.e. expected to come down) to bearish (i.e. expected to move up), the investor also can be ‘dynamic’ by shifting from a long bond fund to a short bond fund. By doing this, he would be turning more defensive on a stable / bearish view on interest rate movement.

RBI monetary policy

So now we come to the crux of the issue: what is the view now? The next RBI Policy Review is scheduled for October 4. To look at the backdrop, in the review on February 8, 2017, the Monetary Policy Committee (MPC) had changed stance from accommodative to neutral. In the review on August 2, 2017, the MPC reduced the repo rate by 25 bps from 6.25% to 6%. Currently, inflation is within the targeted band, but showing upticks. GDP growth rate, at 5.7% for the quarter April-June 2017, is below par and there is an expectation that the central bank should give more monetary policy driven stimulus to spur growth.

However, given the latest upward bias in inflation, i.e., CPI at 3.36% and WPI at 3.24%, question marks on fiscal deficit target of 3.2% and the US Fed expected to unwind from October, it is likely that RBI would stay put on rate action on October 4. What are fund managers doing? A study of a basket of 22 dynamic bond funds shows that the average portfolio maturity of these funds is almost nine years, which shows that fund managers are moderately bullish. The maximum portfolio maturity in this basket is 16 years and on the lower side it is five years. Net-net, existing investors in dynamic bond funds can stay put. Even though the policy stance of the RBI MPC is neutral, there is a case for some further policy rate easing, driven by real positive interest rates, inflation being within target and GDP growth being sub-optimal. As and when the interest rate cycle turns, which is some time from now, existing investors may take a switch call.

For fresh investments in dynamic bond funds, the case is not strong. We are nearing the end of the policy rate easing cycle. Even if a fund manager takes the right calls in portfolio maturity maintenance, the alpha to be generated may not be substantial. Rather, the investor should be conservative right now as there is a tax angle in switching before completion of three years of holding.

The writer is managing partner, Sen & Apte Consulting Services LLP

Oversight of rating agencies: Piecemeal to structured

When we hear the term ‘defaulter’, we relate it to a sub-standard borrower but not with the rating agency that lagged in its job

Article in Mint published on 15 August 2017. For link to original article please click here

A few companies faced sharp rating downgrades in 2015 and 2016 in India, subsequent to which opinions were voiced, and the Securities and Exchange Board of India (Sebi) issued certain guidelines in November 2016 and then again recently, on 30 June 2017, asking rating agencies to monitor issuers more closely. Rating agencies rate a host of instruments like bonds, money market instruments, structured products, and others as well. These ratings are the barometer or the guide that investors use to take exposure in the rated instruments. While the aim of these guidelines is to help the cause of investor interest, there is a better way to streamline the oversight of rating agencies. We will discuss that, but let us first look at the gist of the latest circular.

A prominent point raised in the circular is that sometimes rating agencies are behind the curve; the market knows about a delay by an issuer in servicing debt, but not the rater. The rating agency is either not aware or is yet to act in terms of rating action. Sebi has mandated rating agencies to monitor servicing of debt obligations, based on International Securities Identification Number (ISIN), and track deterioration in financials for early leads. While this should have been par for the course for raters, sometimes it takes the regulator to remind the basics. This raises two issues: either (a) rating agencies are understaffed, and are unable to track issuers properly; or (b) they are running more for fresh business than tracking the issuers rated. Or, it is both.  

The circular says the rating agencies should monitor exchange websites for disclosures by issuers. Again, a reminder of basics. The onus is being put on the rating agency to engage with the debenture trustee and if no confirmation of interest or principal repayment on any outstanding security is received within 1 day post the due date, the rater has to follow up with the issuer. If no confirmation is received within 2 days, the fact has to be disseminated on the credit rating agency's website as a press release, and exchanges have to be informed as well. The rating agency has to inform Sebi, and any failure to pass the information shall be considered as aiding and abetting the issuer in suppressing information. 

When we hear the term ‘defaulter’, we relate it to a sub-standard borrower but not with the rating agency that lagged in its job of tracking the company and disseminating information. In this circular, Sebi has not used the term ‘default’ (it has used ‘failure to make reference’), but in a way, for the first time, we see something on lines of ‘default’ by a rating agency. Another phrase we have been hearing is ‘rating the rater’.

Sebi also mandates that all material events or corporate action by the issuer should be reviewed by the rating agency, and the outcome, which could be re-iteration of the existing rating, should be published as a press release on the website, within 7 days of the event. The regulator has also provided for a situation in which all this does not work. There would be a ‘no default statement’ every month from the issuer. If the rating agency lags, it would mean a lag of a maximum of 1 month. If documents like PAN and Aadhaar need to be self-attested by us, ‘no default’ should be self-attested by the issuer.


Even after all these stipulations, and the stipulations of November 2016—that the rating agency should explain sharp changes in ratings and all ratings should be published on the website whether accepted or not, to prevent ‘rating shopping’—investors are left hopping through websites of all rating agencies. As a user of the rating data, I have to know which agency(ies) has rated that particular issue and then hunt the websites. 

Subsequent to the recent guidelines, Sebi will have to track the data furnished by rating agencies. Rather, there should be a central repository of the information, hosting everything on one website. The advantages of doing so will be multiple:

•It will provide the current rating and entire rating history across all agencies. A user does not need to know which agency has rated which security or search through various websites;

•Any negative event like delay in debt servicing would be disseminated faster as investors would need to check only one website for daily updates;

•Rating agencies can submit the updates to this central body, which would in turn submit the gist to Sebi for any further action;


•Since this entity would be set up under the aegis of Sebi, it can analyse the data for rating consistency and instances of delinquencies across rating agencies periodically;

•This will provide a benchmark for investors as well as issuers for pricing the service of credit rating; 

•Any sharp changes in rating and the explanation from the rating agency can be highlighted in a separate section;

•Sebi is against ‘rating shopping’ (obtaining a rating and not using it if the issuer does not like it). A central repository website can disseminate information on all ratings obtained, used or not, across rating agencies;

•Cost would be reasonable since a small team with the requisite infrastructure can handle it. This would be similar to the entities that compute the equity indices for NSE and BSE. 

Joydeep Sen is the managing partner, Sen & Apte Consulting Services LLP


Of inflation, real returns and senior citizens

Article published in Mint on 6 September 2017. Click here to view site

Inflation-adjusted term deposits that give guaranteed real returns may be the answer to senior citizens' woes of inflation eating into their retirement income


In a scenario of falling interest rates, it is a common refrain, and a valid one, that senior citizens who draw their sustenance from a kitty parked in bank or post office deposits see their regular interest income dropping.

To be fair (and practical), if overall interest rates in the economy are coming down, bank and post office deposit rates would come down as well.

There is usually an enhanced rate offered to senior citizens, of about 0.5%. To look at the reason why rates come down at all, while there are multiple reasons in a dynamic world, but the one factor that stands out is inflation. To put it simply, when inflation is low or falling, the central bank of the country would reduce interest rates, and increase rates when inflation is high or rising.

When inflation is high or rising, the ‘real’ interest rate for savers is impacted to that extent. To offer protection from high inflation, we have seen initiatives from the government earlier, in the form of inflation-linked bonds, where the return to the investor is adjusted for inflation. The first were the wholesale price index (WPI)-linked bonds and the next were linked to the consumer price index (CPI).

If inflation is higher, the payout would be higher accordingly. However, both these bonds were not successful, due to different reasons, but in essence their product design had certain constraints. 


 For senior citizens, it is not just the interest rate but the real interest rate that matters. Inflation is currently on the lower side, and real interest rate is high, according to India’s historical standards.

In this scenario, it may seem a bit out of place to talk of high inflation and low real return. However, the best time to prepare for war is during peace.

Let us deliberate on what is a better solution.

One solution is to bring another issuance of CPI-linked bonds so that in case inflation moves up, senior citizens are compensated to that extent. But in that case, they will have to go through the rigmarole of understanding and applying for the bonds.

The better solution is to instead offer higher returns to senior citizens on deposits, to guarantee a minimum real return, with conditionalities. The deployment avenue—which everyone understands, even rural investors—is term deposits.  


The deposit product design could be something with a tenure of 5-8 years. Premature withdrawal would be allowed, but without inflation protection. The minimum age would be 60 years, and the maximum investment allowed can be Rs10 lakh per person.

Most importantly, the real return would be guaranteed at 3% per year, linked to the consumer price index. 

The benefit of guaranteeing a minimum real return vis-à-vis inflation-indexed bonds will be as follows: 

• Senior citizens would be spared the effort of having to understand a new product, that is, inflation-indexed bonds. Many of them park their savings in deposits anyway, which have to be linked with PAN and Aadhaar to satisfy the conditions of minimum age and maximum amount. 

• The administration would be simple. The earlier products, the WPI and CPI bonds, did not succeed due to flaws in their design.

While a lot of research may have gone into designing the two bonds, there were limitations. Instead of another attempt in the same direction, it would be simpler to have a link to bank and post office deposits. 

• Access to term deposits would be better. Majority of the target population would be covered as public sector banks and post offices are located across the country.

People who prefer physical investments over financial investments, particularly in rural areas, can be weaned to inflation-linked deposits, thereby enhancing the habit of financial savings. 

• The product will offer more flexibility to senior citizens. An inflation-indexed bond will have a defined tenure as it is not possible to customize it for various investor preferences. On the other hand, term deposits within a defined maturity bracket would qualify for real interest rate.

This would give senior citizens some choice, and even those who are not financially savvy can understand term deposits. 

• The cost to the government can be taken care of in a pragmatic manner. Going by the current levels, with a bank fixed deposit rate of 6.5% (or 7% for senior citizens) and latest CPI inflation data of 2.36%, the real interest rate is 4.14% (or 4.64% for senior citizens).

The government need not guarantee the current level of real return; it can be set as per historical levels and expected realistic levels on inflation. 

• While there will still be a cost for the government, this will be a social benefit measure, with a positive impact on voter base.

Let’s admit it, governments work for social good but with an eye on the vote bank.

The cost will be much lower than agriculture loan waivers where the entire loan is waived. This will be just a marginally incremental interest payout for a section of the depositors. 



Should you recommend credit-play corporate bond funds to clients?

Published on on 10 March 2017. View the original article here.

IFAs can look at recommending a limited exposure, say 15% to 20% of the fixed income allocation of the portfolio to credit opportunity funds of well managed AMCs.
— Joydeep Sen on 10 March 2017

The return ‘alpha’ in fixed income funds i.e. returns over and above the baseline return from liquid funds can come from (a) managing the duration of the portfolio i.e. maintaining a long portfolio maturity when interest rate view is positive or (b) the credit exposures in the portfolio

Since the scope of ‘duration play’ looks limited particularly after the change of stance on policy rate easing by the RBI, ‘credit play’ becomes more relevant now.

There are many investment avenues in the debt markets. Credit play debt funds are one such niche investment avenue in the short term bond funds basket and the category AUM is nearing Rs 1 lakh crore, which is approx 5.7% of the industry AUM (as on January 2017) of Rs 17.37 lakh crore and 8.5% of the fixed income AUM of approx Rs 11.7 lakh crore.

Barring one or two exceptions, fund managers do not mix up duration with credit risk in the same fund as these are two distinct risk plays. Most of the credit play funds have portfolio maturity akin to short term funds. The crux of the discussion in this article is whether it is worth the risk, going for the alpha of higher portfolio yield of credit-play funds vis-à-vis the top-notch credit quality in conventional short term bond funds.

To get a perspective on the credit risk in a ‘credit play’ fund, we will look at the credit ratings of the securities in the portfolio. The portfolio composition of credit-play corporate bond funds is largely in AA and A rated securities against predominantly AAA rated exposures in conventional short term funds. AAA being the top-notch credit rating, it carries the highest level of safety whereas AA and A are high / reasonably good credit grade, subject to due diligence carried out by the fund manager on the companies.

To gauge the default risk in instruments for the respective rating, there is a handy tool, CRISIL default rate study, produced below:

While the table throws a lot of data at us, let’s understand the gist of this:

(a) The probability of default on AAA securities is nil, as per the historical evidence of CRISIL.

(b)The probability of default in A rated papers, when held for one-year, is less than 1% and when held for three years, default probability is less than 5%, which is not alarmingly high.

It is expected that the fund manager will do his job and avoid the potential default candidates. At the end of the day, a credit rating is an opinion of the rating agency and the performance we see above is history. Risk management in a fund is upto the fund manager.

Let us look at the state of the industry, in terms of credit rating break-down in this category:


The data above is a compilation by IDFC MF, on ‘Credit Opportunity Funds’ as categorized by CRISIL. As we can see, the risk in terms of exposure to papers rated less than AAA (light green and maroon bars) has been going up in quest for higher yields. Exposure to A grade has moved up from 6% in Mar 2010 to 39% in Mar 2016. This becomes all the more relevant when we recall the episodes of Amtek Auto, JSPL and BILT; it once again underlines that active tracking of the fundamentals and corporate governance of the underlying companies by the fund manager is vital.

After taking exposure to the higher yielding papers, let us see how much has the portfolio running yield moved up, which gives a perspective on the expected higher return. The running yield of the portfolio is higher by 1.5% to 2% in credit-play funds over conventional short term funds with top-notch credit quality. The recurring fund management expenses being relatively higher in high yield funds, the net running yield is higher by 1% to 1.5%. The issue is: is it worth going for that higher yield at the cost of a little higher credit risk?

On one hand, we have the CRISIL default rate, which is not alarmingly high for investment grade papers, and on the other hand we have incidents like Amtek Auto, JSPL and BILT.  SEBI amended a rule in July 2016, which says restrictions on redemptions may be imposed only when there is a systemic crisis e.g. market-wide liquidity crisis or the exchange getting closed for transactions or there is an operational black-out. The meaning of this message is that the ‘side-pocketing’ i.e. separating the bad assets from the portfolio to another small fund that was allowed to one AMC in the Amtek Auto episode will not be allowed in future. It is the AMC’s responsibility to do proper risk management and ensure redemptions to all investors.

Key takeaway: The advisor may recommend a limited exposure, say 15% to 20% of the fixed income allocation of the portfolio, in credit opportunity funds of AMCs with a track record of managing credit funds and having a good risk management system in place. Assuming less-than-AAA exposure at 70% in credit opportunity funds, 20% exposure to these funds implies 14% of the fixed income component being in ‘credit play’. For zeroing down on credit-play funds, it is advisable to opt for well-diversified portfolios, even if the AMC has a good risk management system. The reason is, if the portfolio running yield is higher by 1.5% over conventional short term funds and a credit exposure of 1.5% of the portfolio goes bust (unlikely, extreme case scenario) the investor is at par with other short term funds in the worst case.

Mutual funds: How to take advantage of ‘March phenomenon

Published in Financial Express on 10 March 2017.

In the money market, which is the market for very short maturity instruments, interest rates move up due to higher demand for money. The peaking of interest rates happen typically around the third week of March, since corporates and banks do not wait for the last moment to manage their balance sheets.
— Joydeep Sen on 10 March 2017

Every year, something happens in the money market in March: System liquidity tightens. This happens due to:

(a)Advance tax outflows of March 15 lead to money flowing out of the banking system into the government’s account with RBI,

(b) higher demand for cash from corporates due to year-end balance sheet reasons and

(c) money market instruments like bank certificate of deposit (CDs) issued earlier maturing in March and banks issuing fresh CDs leading to demand for money.

In the money market, which is the market for very short maturity instruments, interest rates move up due to higher demand for money. The peaking of interest rates happen typically around the third week of March, since corporates and banks do not wait for the last moment to manage their balance sheets. System liquidity eases in April, as money flows back from the government’s account with RBI in the form of government expenditure and demand from corporates and banks is not as much. Interest rates on these ease gradually as we move from March to April.
Impact on retail investors. Now let’s look at the implication of this phenomenon on retail investors. The mutual fund categories that invest in money market instruments are liquid funds and ultra short term funds. Since interest rate and price of instruments move inversely, when interest rates move up, prices of instruments are impacted and returns from existing investments in ultra short term funds are impacted as well. The other side of the coin is that those who have funds to invest in March, and don’t require it soon, can take advantage of this. As and when interest rates ease from March to April, prices of instruments move up and returns are that much better. The ‘March to April’ phenomenon is played out by investing in ultra short term funds around third week of March and redeeming in April or May.

High system liquidity
However, this March is different. This year, system liquidity is surplus so far. This is due to

(a) demonetisation and consequent higher deposits with banks and

(b) lower credit off-take by corporates from banks as there are spare capacities.

Though it will tighten after March 15, it will not be as tight as in other years. Interest rates would move up to a little extent, but again, not as much as in other years. Thus the incremental returns of the ‘March to April’ phenomenon discussed earlier won’t be as much as in other years.

This is relevant for investors deliberating between liquid and ultra short term. Liquid funds are meant for parking of funds for very short periods like few days to few weeks. The rationale is, this category is the most stable in performance as the maturity of all the instruments in the portfolio are less than three months and impact of fluctuations in the underlying market is lowest.

Opt for plain liquid funds
At times, investors park in ultra short term funds for the return uptick over liquid funds. At this juncture it is advisable to opt for plain liquid funds, particularly if investment horizon is within March 31. There would be some volatility in ultra short term funds due to the March liquidity phenomenon. If the investment horizon stretches well into April, investors may consider ultra short term funds and investment should be made after March 15 advance tax outflows.

– Joydeep Sen