Without unlocking, default rates could rise

DSP Investment Managers president explains why credit-risk funds have suffered, why short-term debt funds are safer bets and how asset-allocation funds can help investors make the right decisions.Bond funds have seen a lot of turmoil recently. Do you think the worst is over?The credit-risk category has gone through some turmoil because some parts of the economy were facing liquidity challenges. The category has shrunk significantly in the past few months as most of the money moved to the high-quality bucket of short and medium-term funds. Investors must recognise that every debt fund has interest rate risk as well, especially when interest rates are very low, and set their expectations right. What could happen after the moratorium ends?There is a fair bit of uncertainty right now. We are watchful on how the economy evolves post lockdowns and moratorium and look for data points on the ability of small and mid-sized borrowers to start paying their dues to lenders. If lockdowns last longer and the economy does not open up faster, smaller companies will face challenges. Loans could get restructured and there could be a rise in default rates.What is your advice to debt fund investors?Invest in debt funds primarily to preserve capital and earn the prevailing rate of interest. In India, the yield curve is steep. The interest rates of 2-5-year bonds are higher than what 6-month bonds offer. Short-term debt funds, by mandate, invest in 2-5-year average maturity bucket and get benefit of these yields. Due to the mandate to stick to three-year duration, investors don’t have to worry if rates on long-term bonds rise sharply after having come down in the past few years.Rebalancing and asset allocation are critical for investment success. But investors often falter here. How can investors get their asset allocation right?It is more important to be in the right asset class than being in the best-performing option of the wrong asset class. When the market multiples are very high, the margin of safety is low. In January and February this year, before Covid struck, markets were rising and reached a multiple of 28 times. It was clearly not logical to be aggressive on equities at that point. So our Dynamic Asset Allocation fund cut its equity exposure to 40-50%. In March, when stock prices fell by 40%, the fund fell only 17%. There’s more to this than just avoiding a fall. As markets crashed, the valuation fell from 28 times to 17 times. The formula driving the fund’s allocation indicated that it was time to be overweight on equities. So the equity exposure was raised to 70% and the fund has gained from the rebound in stock prices. It may not have gone up as much as the market, but did capture 70% of the upside. Now that valuations are rich once again, the fund has reduced its equity exposure to 50%. The real beauty of this model is that it takes emotions out of the investing decision. The market crash in March was a great opportunity to invest. But, left to himself, an investor would not have mustered the courage to invest at that time. No matter how evolved or informed an investor may be, he won’t be able to control the behavioural instincts that shape his decisions during extreme market conditions.But asset-allocation funds don’t do well when markets are rising.In the long run, following asset allocation may not promise higher returns to the investor. However, it controls the risk in the portfolio, especially when markets fall sharply. This, in turn, provides comfort to the investor, which prevents him from exiting in panic and then missing the eventual upside in the market. So, asset-allocation funds are behavioural, defensive products rather than return-enhancing products, which ensure that investors stay put. They are like seat belts which give us comfort that we will navigate the turbulence smoothly. 77898380

from Economic Times https://ift.tt/2Z18vAp