Should these bonds form part of your portfolio? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster
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Should these bonds form part of your portfolio? 

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In this issue:
» Will India see a pickup in GDP growth?
» Buffett's words of wisdom to the next generation
» Does the US Fed need to trim its balance sheet?
» Mr Modi may not be in favour of divestment
» ...and more!


00:00
 
A junk bond or a high yield bond is a bond that is rated below investment grade. These bonds have a higher risk of default or other adverse credit events. But they offer yields in excess of better quality bonds so as to make them more attractive to investors.

The West is no stranger to junk bonds. These became quite famous in the mid 1980s and were lapped up by investment banks in leveraged buyouts and various mergers & acquisitions.

However, recent times have also seen the resurgence of these bonds. In the West, the central bankers have kept interest rates close to zero in the hopes of fuelling economic growth. As a result, there has been a dearth of investment options for investors looking for better returns. That is one of the reasons why the 'high return' aspect of junk bonds has so enticed investors.

The trend seems to be catching up in India too. As reported in an article in the Mint, two NBFCs in Kerala have issued speculative grade bonds to finance their operations as well as refinancing existing debt. Both these issues have been rated BB+ by the credit rating agency CARE. What more, despite the high risk nature of these bonds, the response to them seems to be quite good.

There is a likelihood that the issuance of these bonds could go up going forward. Because of high interest rates and sluggish economic growth, many small companies are strapped for cash. And issuing junk bonds is one such avenue that they may consider to raise funds.

Should retail investors dabble in junk bonds? No doubt the prevalence of bonds of varied risk profiles adds more depth to the bond market. Junk bonds typically offer yield of around 4-5% above government securities (G-secs). Top rated bonds offer a yield which is around 1-2% higher than G-secs. So the lure of high returns is very much there.

But there is a reason why the yields are high. And that is because the risks, especially of default, are very high too. What more, one can never be too sure whether the higher return offered is sufficient enough to compensate for the high risks involved.

SEBI had relaxed the norms for issuance of junk bonds in 2007 but it very clearly stated that it is upto the investor to decide whether or not he wants to invest in the same. Thus, it is important that investors understand the full nature of these bonds and the risks attached to them before they choose to invest their hard earned money in these instruments.

Do you think that more junk bonds will be issued by Indian companies going forward? Should retail investors consider investing in junk bonds? Let us know in the Equitymaster Club or share your comments below.

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01:36  Chart of the day
 
The past couple of years have seen India's GDP growth considerably slow down. But even more troubling is that India has largely been the victim of policy deadlock since a decade now. The laws have been crying out for an overhaul. But post elections, the tides have turned for the better. The euphoric elections have possibly paved way for India's new growth story. India today stands on the cusp of growth with GDP expected to accelerate to 6.8% in next two years. Not just that! America's leading multinational financial services firm Morgan Stanley also believes that India is expected to emerge from stagflation. Stagflation is an economic situation wherein the inflation rate is high, the economic growth is slow and the unemployment remains higher. But Morgan Stanley reckons that this scenario is soon to turnaround. While the GDP is expected to accentuate, the inflation rate might return to central bank's desirable levels of 6%.

The new government is expected to revive business sentiment thereby lifting corporate profitability and kick-start the investment cycle. While that may be true, the global risks might play spoilsport. Also, slower than anticipated pace of reforms and the possibility of an El Nino phenomenon cannot be ruled out. These might continue to throw up challenges for the new government in power. Therefore, it might be too early to claim that the worst is behind for the Indian economy.

Will India see a pickup in GDP in the coming quarters?

Editor's Note: As markets touch lifetime high, do you think it is time to book profits and re-enter the market at a later stage? Or could this be the start of a new bull run that could take Sensex across the 30,000 mark? Get answers to questions like these and many more in Equitymaster's biggest WebSummit ever!

02:15
 
A good teacher can have a lifelong impact on the virtues and success of the student. Warren Buffett for example credits Benjamin Graham for his legendary success in creating wealth through value investing. Buffett himself has proven to be a teacher par excellence. For there is no other source better than his letters to shareholders that reveal the secrets of value investing year after year. Humble that he is, Buffett does not shy away from even recounting his failures and mistakes. Just so that the readers of the letter and fellow investors learn from his mistakes. In fact in some of his letters, he has also offered tribute to fellow value investors like Walter Schloss. In doing this, he has discussed the latter's value investing based investment strategy. Thus, Buffett's teachings have been all encompassing for the students of value investing. In recent years, apart from his wealth creation and philanthropic interests, Buffett has always made a fair effort to share his wisdom. And his latest attempt seems to be targeted at the next generations. Secret Millionaires Club is an animated cartoon series wherein Buffett is introducing tenagers to the principles of investing and entrepreneurship. And we must say the value investing guru does a very good job of putting across his ideas in the most lucid manner!

02:57
 
Ever since the US Fed has expanded its balance sheet to unimaginable levels, doubts have been raised on how exactly will the same be shrunk? In other words, it will be next to impossible for the Fed balance sheet to contract without having a great impact on the US bond market. However, former Fed Chairman Ben Bernanke has found a way around this dilemma. He has argued that there's absolutely no need for the Fed to shrink its US$ 4 trillion plus balance sheet when the time comes for it. As per him, the balance sheet could be kept where it is for a very long time if necessary.

Well, we believe that this comment is nothing short of outrageous. To expand Fed's balance sheet by as much as it has and still expect no significant damage comes across as pretty bizarre to us. The inflation is current low in the US simply because people are not out spending and businesses are wary of adding new capacities. The excess liquidity is therefore finding its way into stocks and emerging market assets. But once it starts seeping into other areas of the economy, prices are likely to shoot up and give a lot of reasons for the Fed to worry about. In short, it looks highly unlikely that the Fed continues to maintain its balance sheet size without a major crisis of any kind.

03:36
 
The divestment department is in a dilemma over the mandate it may get once PM in waiting Narendra Modi resumes office. If Modi's past record is anything to go by, the divestment department will find itself out of work when it comes to raising cash from stake sales. In other words, his administrative style is to empower PSU bureaucrats and revive those sick/poorly managed units rather than indulge in stake sale via divestments. At least this is what he has been doing with Gujarat PSUs. So, if the same approach is followed at all India level, the finance ministry could well be in for a cash crunch. No divestment means less money for the government coffers. This may make funding fiscal deficit a big challenge. It may be noted that the earlier government used PSU divestment as a tool to fund fiscal gap. However, if Mr Modi does believe in empowering PSUs, than he and his finance minister will have to think of innovative ways to bridge the burgeoning fiscal gap. It would be interesting to see how the Modi administration deals with this issue.

04:10
 
Jim Rogers is known as one of the leading experts on commodities in the world. He correctly predicted the big bull market in commodities of the last decade way back in 1999. So when he recently shared his views about Gold, we were all ears. Rogers believes that as an investment, Gold has excellent long term prospects. Why? Well he is of the view that reckless money printing by central banks around the world will be the cause of a world-wide disaster.

The huge bubble of debt that has been built up will burst in the years ahead. According to Rogers, the world will not be able to deal with this shock and several economies could tear apart. He does not rule out the possibility of a war. Thus, even though the short term prospects of Gold may not seem very promising, the long term fundamentals of the yellow metal remain intact. Despite the fact that gold prices have been on a downtrend since September 2011, he has not sold any of his holdings. We agree with his assessment and have always maintained that investors should keep about 5-10% of their portfolio in Gold. This will hedge the portfolio against a global economic meltdown.

04:45
 
The Indian stock markets were static, trading around the dotted line. At the time of writing, the benchmark BSE-Sensex was up by 18 points. Most of the sectoral indices were trading in the green with realty and consumer durables stocks leading the gainers. However, oil and gas and banking stocks were trading in the red. Most of the Asian stock markets were trading strong led by Hong Kong and Japan. European markets opened the day on a mixed note.

04:56  Today's investing mantra
"You ought to be able to explain why you're taking the job you're taking, why you're making the investment you're making, or whatever it may be. And if it can't stand applying pencil to paper, you'd better think it through some more. And if you can't write an intelligent answer to those questions, don't do it." - Warren Buffett
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4 Responses to "Should these bonds form part of your portfolio?"

joseph mathew

Jun 5, 2014

I am a member of Equity Master from Kochi,Kerala.I think this article has done injustice to those Kerala companies without knowing their base.If you mean Muthoot Finance and Manappuram ,they are not new ones. Muthoot is around a century old and almost half of Kerala's gold lies with these two companies as security against cash loans. They used to accept fixed deposit which doubled in 4 to 5 years.Now as they have to do it under Govt controls, they are issuing bonds which doubles in 6 years.

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Ganesh Sastri

May 20, 2014

For investors a better alternative will be a mutual fund or ETF that invests in JUNK BONDS predominantly. Unfortunately, SEBI has NOT permitted any MF or ETF focusing on junk bonds. There is an urgent need for such a fund that will invest in junk bonds, lend money to real estate firms and FILMS.

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Mohit

May 20, 2014

I dont think its the right time to invest in junk bonds. markets remained volatile and so do the business conditions.

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Pankesh Sethi

May 20, 2014

In coming times, we will see more companies issuing junk bonds. With hope of Indian economy recovery, companies will try to revive their fortunes with capital investments. Government and RBI can keep check on liquidity for sometime as taming inflation will be part of their policy platter.

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