Wealth Management

The Evolving Debt Market: Plan Your Exit Wisely, Just Like Your Investments

September 2018

Read Time: 4 minutes

Over the past two decades, Indian markets have grown at a tremendous pace. The markets have opened up and attracted domestic as well as foreign flows, which have facilitated the growth of a robust financial services industry. This has led to reduction in information asymmetry. The increasing transparency and access to information about the market has made the modern investor more discerning. Investors today understand that meagre returns from fixed deposits and debt fund investments can be juiced up using a proactive investment approach and a better understanding of market dynamics, while keeping risk appetites intact.

Changing Markets, Changing Investors

Along with the investors, the debt market itself has evolved significantly over the last decade. The fixed income market today has higher variability and volatility than before, providing pockets of opportunities to a sophisticated investor. Also, security holding patterns have significantly changed, shortening from a 5-6 year cycle to a 2-3 year cycle. The investor community has moved from the traditional “buy and hold” philosophy to “riding the yield curve”. This shift has changed the long-term conservative investment approach, and along with it, the manner in which investors relate to them.

The financial services industry is now helping investors take cues from macro developments to make superior investment decisions. Even a relatively conservative space such as the debt market has now become a vibrant arena for profit making. Investors are on a constant lookout for opportunities which may provide them with the ability to maximize their returns, while holding on to the capital preservation benefits that an asset class offers.

Riding the Yield Curve

In a market fraught with rising interest rates and volatile yields, the means to maximize results requires careful planning and timing. Investors require an upgrade in the way they approach the debt market. 

Let’s recall 2008 for a moment – the 10-year G-Sec yield fluctuated between a high of 9.478% in July and a low of 5.26% in December. An average investor sticking to the “hold-to-maturity” mindset would have locked in a maximum yield of 9.478%. However, a tactful investor would have utilized the inherent volatility in yields to make an absolute return of 16.872% through a combination of capital gains and interest earned- a great outcome in a recessionary environment. The winning strategy here, called “Riding the Yield Curve” is straightforward. In a rising interest rate scenario, this means buying relatively cheaper longer-term instruments and exiting once the yields come down, thus benefitting from the “marked-to-market” earnings. 

A “Riding the Yield Curve” strategy helped produced stellar returns in the period post the 2008 financial crisis. The US Federal Reserve’s quantitative easing program resulted in reduced short-term interest rates, steepening the yield curve. Bond traders used this opportunity to buy longer maturity bonds at cheap prices, and sold them off when the yields curve flattened later.

To illustrate one such trade, imagine an investor who buys a 10-year zero coupon bond with a face value of INR 100 and yield of 9% in an environment of steep interest rates, implying a market value of INR 42.24 (100/1.0910). After three years, if the interest rates have fallen and yields have stabilized to 7%, the investor can sell the same bond for INR 62.27 (100/1.077). In this process, the investor makes a capital gain of INR 20.03, in 3 years, implying a holding period return of 48%.

Many fund managers and financial advisors seem to overlook the significant role of exit timings and continue to operate on the traditional advice of a “buy and hold” strategy. This approach could lead to clients missing out on the best possible return for their investments, at least over the shorter term. 

The Avendus Advantage

The wealth management team at Avendus believes that ensuring capital preservation and winning higher returns are not mutually exclusive goals. Our research and analytics teams continuously track the changing trends of the debt market to generate actionable insights that translate into superior investment recommendations. At Avendus, our debt market investors are at ease knowing that we place a strong emphasis on timing their exits to maximize their returns. 

Author: Swati Singh, Executive Director and Head, Fixed Income, Avendus Wealth Management

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