Index inclusion a game changer for Indian fixed-income markets: Vishal Goenka (2024)

Let's start with a basic question- why should investors consider investing in bonds? What factors should one keep in mind before considering bonds as an asset class?

The answer is simple: all financial investors should diversify their portfolios as the basic thumb rule of financial investments.

Bonds offer low volatility and diversification as well as provide regular stable income which is essential for everyone.

Previously access to bond investments was not possible for the individual investor and now due to technological innovation and protective regulation, this asset class has been enabled for all via SEBI-regulated online bond platforms like IndiaBonds.com.

Bonds also serve as an ideal asset class for more moderate and risk-averse investors and in some cases provide capital preservation and additional income to supplement people’s financial wellbeing.

Bonds, like every other financial asset class, also have certain risks.

Investors must read offer documents and rating reports to understand the issuer. The main factors to keep in mind are coupons, yield or returns at the time of investment, maturity and credit ratings; plus, risk factors such as credit, interest rate and liquidity before investing.

Furthermore, aligning bond investments with investment goals and time horizons is essential along with understanding market conditions and their impact on bond prices. Following the above will one in making informed investment decisions.

Also Read: Indians buy gold bonds worth a record ₹8,000 cr in February

Fixed deposit (FD) versus bonds- what should retail investors go for at this juncture?

Both FDs and bonds offer avenues for investment with their respective benefits and shortcomings.

FDs have a ₹5 lakh government guarantee but are usually for shorter tenors, non-transferable with lock-in periods and penalties on early exit.

Also Read: Best fixed deposit rate: Which bank is offering the highest FD interest rates and on which tenure

With bonds on the other hand, investors can earn higher returns, select maturity, trade in secondary markets and build diverse portfolios to suit their risk appetite.

Given that we are close to or at peak interest rates in the current economic cycle, bonds are a better option at this juncture for investors to be able to lock in these rates for higher tenors and also have potential capital gains when RBI starts cutting interest rates later this year.

Investors must consider their individual risk tolerance, investment goals and time horizon when deciding between FDs and bonds.

Also Read: Are investors moving from fixed deposits to equities amid rising stock market?

How should the investor build a debt portfolio given that we are currently in a high interest-rate environment?

Globally, professional asset managers suggest a 60:40 rule between equity and bonds for asset allocation.

In India, we suggest at least 25-30 per cent of one’s financial investments be in regular fixed-income earning securities in a debt portfolio.

The rules for building a debt portfolio are to achieve diversity within your investments, buffer for liquidity needs and be able to earn higher returns on some portion which is earmarked for holding till maturity.

Today it is possible for investors to build this on their own on platforms like ours, where there are 125+ live bonds to choose from at any time across the risk spectrum.

Given the current high interest-rate environment, it is good for investors to go for the average maturity of a portfolio which is three to five years.

This should have 25 per cent in long-dated government bonds or bond strips, 25 per cent in high-yielding two-to-three-year maturity bonds rated ‘A’ yielding between 10-13 per cent and the rest 50 per cent in ‘AA’ PSU/bank category which yields 8-10 per cent.

This could help to build a good balanced portfolio with potential upside.

All allocations would ultimately depend on the investor’s own investment goals and risk appetite.

How will the bond market investment scenario change in 2024 after the JP Morgan inclusion? How is the bond market growth going to be after the JP Morgan Index inclusion?

JP Morgan Index inclusion of India Government Bonds is a watershed moment for the fixed-income markets in India and very welcome.

This compulsorily puts Indian bond markets on the radar of global bond investors and although initial investments are supposed to be to the tune of $20-30 billion, index inclusion paves the way for this number to keep growing in the next few years.

It is important to grow the investor base for any market, and index inclusion helps in expanding the number of players, which further benefits everyone in the form of additional market liquidity.

Global investors have been looking to allocate capital to emerging markets given their reluctance to invest in other large countries like Russia or China in the past couple of years.

Hence, the timing of this index inclusion is also almost perfect.

I reckon investments will start via government bonds initially, but filter into AAA to lower credit ratings as well in the years to come.

Truly a game changer for the Indian fixed-income markets.

Bloomberg Index Services has decided to include India's Fully Accessible Route (FAR) bonds in the Bloomberg Emerging Market (EM) Local Currency Index from January 2025. How could the bond market investment scenario change after this?

Following from the above on the impact of JP Morgan Index inclusion of India Government Bonds, inclusion in Bloomberg EM Local Currency Index will have similar long-term and global effects even though the additional index investments are supposed to be smaller in the region of $2-3 billion.

Also Read: Bloomberg to add Indian bonds to EM debt indexes from January 2025

How are factors like inflation, rate cuts and higher yields affecting investment sentiments?

Inflation: When prices rise in an economy due to inflation, it chips away at the purchasing power of people.

Fixed-income investments like bonds fall in price/rise in yield as investors start clamouring for higher yields to make up for the diminishing real returns.

Elevated levels of inflation for long periods can trigger bond sell-offs causing steep falls in prices driving prices down and upsetting the financing cycle in an economy.

Hence, inflation targeting and price stability remain an important objective of almost all central banks globally including in India.

Rate cuts: Central banks often turn to interest rate cuts to give the economy a boost by making borrowing cheaper against the backdrop of low inflation and/or a slowing economy.

This move can send bond prices soaring, as older bonds with higher yields suddenly become more attractive.

However, if low interest rates stick around for too long, it might signal economic weakness, making investors a bit jittery about future returns, especially on corporate bonds.

Higher yields: Rising bond yields can be a double-edged sword for investors.

On one hand, they could mean bigger payouts and returns. But on the flip side, they could also mean losses for existing bondholders as bond prices move in the opposite direction.

Plus, higher yields may make refinancing for smaller companies much more difficult leading to a potential spike in credit defaults in a country causing further economic stress.

Could you please highlight the five most important developments in the bond market after the coronavirus pandemic in 2020?

The five most important developments have been:

(1) Bond market growth: As per data from SEBI and CCIL, the aggregate bond market (government plus corporate) stood at ₹133 lakh crore in March’20 which has grown by 58 per cent as of the latest data of Dec’23 to ₹209 lakh crore. This is roughly $925 billion at current US dollar/INR exchange rates.

(2) Rise of OBPPs (online bond platform providers): Technology-enabled online websites came about three to four years back selling bonds to individual investors.

SEBI regulation in Nov’22 provided a framework to grow this market in a safe and regulated environment with investor protection in mind.

This has spurred retail participation in bonds and we predict a dramatic rise in bond investments by non-institutions in the coming years.

(3) Global index inclusions: As mentioned above, the inclusion of Indian Government Bonds in global indices such as JP Morgan and Bloomberg will bring in a new very large set of global investors and will be a game-changer for India's fixed income.

(4) Seasoning of the Indian Bankruptcy Code (IBC): IBC was introduced in 2016 to help fast-track recoveries from corporate defaults through the NCLT process.

For a robust corporate bond market to exist, a regulated framework for recovery is essential. Today corporate India is very aware of the consequences of default which has strengthened the investor position in recent years.

(5) Rise of private credit: An important sub-asset class which has seen tremendous growth has been private credit in India by domestic/foreign institutions via the popular AlF (Alternative Investment Fund) route.

We envisage that corporates will raise more capital via the public issue of bonds or private credit and away from just traditional banking channels.

How have bonds as a fixed-income asset class performed in the last few years in terms of returns and growth?

If we take the last five years' data, it includes the extreme movements during the onset of COVID-19 in the first half of 2020.

Government bond markets rallied more than 150bps with 10-year bonds touching a low of 5.75 per cent.

Post-pandemic, due to a massive infusion of liquidity and support globally, bond yields moved higher hampering returns.

Then came the inflation genie which ensured central banks hiked rates globally resulting in the short-term rates going higher rapidly.

India, however, has been fairly insulated from the extreme moves and our bond market has demonstrated much lower volatility as compared with the US markets.

This means that returns have been good at steady high rates since last year and now with the potential of capital appreciation in future.

As mentioned above, the fixed-income asset class has grown (and matured) a lot in India in conjunction with the growth in our overall GDP and equity market cap.

Since Mar’2019, bond markets have grown by 74 per cent to currently stand at roughly $2.53 trillion as of Dec’23 as per SEBI and CCIL data.

There are expectations that the Reserve Bank of India (RBI) will start reducing interest rates after May or June. How will it impact the bond's value?

It is indeed market expectation that RBI may start cutting benchmark rates which it has held constant since Feb’23 at 6.50 per cent in the next three to six months.

Interest rate cuts cause bonds to perform very well with a rise in their prices or a fall in yields (returns).

We would expect the shorter-term rates, in the two-three-year bucket, to fall the most and this is a good tenor for investors to buy corporate bonds.

This strategy should be supplemented with part of the portfolio in long-term government securities as they would move the most in price terms on any rate cuts in future.

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Disclaimer: The views and recommendations above are those of the expert, not of Mint. We advise investors to check with certified experts before making any investment decisions.

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Published: 06 Mar 2024, 12:08 PM IST