In order to avoid credit events that have hit mutual fund fixed income schemes, investors are subscribing to bonds in public debt issues. All the public debt issues are of NBFs and HFCs and while the issuers have been rated high safety and above, investors are taking on portfolio concentration risk in terms of single issuer and also sector concentration risk. Investors are taking lots of risk by buying into public or retail lots of secondary market.
Topping it all, unlike equity, credit risk is difficult to measure and track, as most non institutional investors do not track credit spreads, interest rate movements and market liquidity for bonds.
Since September 2018, when IL&FS defaulted on debt, issuer ratings have come under high scrutiny as AAA ratings have turned into default or have been downgraded close to default. IL&FS, DHFL, Essel Group, Reliance ADAG Group have all been downgraded sharply and bonds worth around Rs 7.5 trillion have been downgraded across the board.
There is no guarantee that public debt issuers will not get downgraded to default, the only source of comfort for investors will come from continuous credit analysis of the issuers, which investors do not have the tools to carry out.
Shifting from mutual funds or fixed deposits to direct bonds is best avoided unless there is a good credit advisor backing the shift with fundamental, independent research notes.
The bond is a debt security, under which the issuer owes the holders a debt and is obliged to pay them interest and to repay the principal at a maturity date. Bonds and stocks are two different securities, but the major difference between the two is that (equity) stockholders have an equity stake in a company whereas bondholders have a creditor stake in the company. Being a creditor, bondholders have priority over stockholders. Also, on a complete portfolio basis, bonds do offer diversification and offers fixed interest payments (depends on credit worthiness of the issuer).
Mid of 2018, equity markets across the globe have witnessed volatility, which led many retail investors to take a paradigm shift in their portfolios from 100% direct equity to buy into bonds that were offering higher yields. Most of them have no clue about risks of holding bonds in personal portfolios. Major risks while holding on bonds include – Prepayment risk, credit risk, reinvestment risk, inflation risk, yield curve risk and exchange rate risk.
Bond prices can become volatile depending on the credit rating of the issuer – for instance if credit rating agencies like Standard and Poor’s and Moody’s upgrade or downgrade the credit rating of the issuer. An unanticipated downgrade will cause the market price of the bond to fall. For example, IL&FS was rated AAA (highest rating) in August 2018 which has been downgraded to D in September 2018. This downgrade has tumbled the prices of all assets across bonds & equities as investors started a panic sell-off.
A company’s bondholders lose much or all their money if the company goes bankrupt. Under the laws of many countries bondholders are in line to receive the proceeds of the sale of the assets of a liquidated company ahead of some other creditors. There is no guarantee of how much money will remain to repay bondholders. In a bankruptcy involving reorganization or recapitalization, as opposed to liquidation, bondholders may end up having the value of their bonds reduced, often through an exchange for a smaller number of newly issued bonds.
Some bonds are callable, meaning that even though the company has agreed to make payments plus interest toward the debt for a certain period of time, the company can choose to pay off the bond early. This creates reinvestment risk, meaning the investor is forced to find a new place for his money. As a consequence, the investor might not be able to find as good a deal, especially because this usually happens when interest rates are falling.