Who’s the biggest…

…Ponzi…

…of them all?

Insurance companies?

There’s someone bigger.

The government. 

Legit.

Probably not going to go bust…

…at least in a hurry. 

Moves money from A to B…

…with minimum accountability. 

Resurrects skeletons and gives them infinite leases of life…

…with good, clean and fresh funds…

…that flow out of the pockets of helpless citizens. 

So, what about the government’s bond?

Sovereign debt.

The herd is flowing to sovereign debt, and to some extent to 100% AAA max 3 month paper duration liquid funds. 

This is after the johnnies at FT India miscalculated big-time, and had to wind-up six debt mutual fund schemes in their repertoire.

Should one do what the herd is doing?

Let’s break this down. 

First up, the herd exited credit-risk funds en-masse, post FT India’s announcement. Logical? Maybe. Safety and all that. Took a hit on the NAV, due to massive redemptions. I’m guesstimating something to the tune of 3%+. 

This seems fine, given the circumstances. Would have done the same thing, had I been in credit-risk. Perhaps earlier than the herd. Hopefully. No one likes a 3%+ hit on the NAV within a day or two.

Let’s look at the next step.

Sovereign debt is not everyone’s cup of tea. 

Especially the long-term papers, oh, they can move. 3% moves in a day are not unknown. 13-17% moves in a year are also not unknown. A commoner from the herd would go into shock, were he or she to encounter a big move day to the downside in the GILT (Government of India Long Term) bond segment. Then he or she would commit the blunder of cashing out of GILT when 10% down in 6 months, should such a situation arise. This is absolutely conceivable. Has happened. Will happen. Again.

There are a lot of experts advocating GILT smugly, at this time. They’re experts. They can probably deal with the nuances of GILT. The herd individual – very probably – CAN’T. The expert announces. Herd follows. There comes a crisis that affects GILT. Expert has probably exited GILT shortly before the onset of crisis. Herd is left hanging. Let’s say GILT tanks big time. Herd starts exiting GILT, making it fall further. Expert enters GILT, yeah – huge buying opportunity generated for expert.

More savvy and cautious investors who don’t wish to be saddled with the day to day tension of GILT, and who were earlier in credit-risk, are switching to liquid funds holding 100% AAA rated papers.

Sure. 

This is probably not a herd. Or is it?

Returns in the 100% AAA liquid fund category are lesser. Safety is more. How much are the returns lesser by? Around 1.5 to 2% lesser than ultra-short, floating-rate and low-duration funds. 

Ultra-short, floating-rate and low-duration funds all fall under a category of short-term debt which people are simply ignoring and jumping over, because apart from their large size of AAA holdings, a chunk of their holdings are still AA, and a small portion could be only A rated (sometimes along with another smallish portion allocated in – yes – even sovereign debt – for some of the mutual funds in this category).

The question that needs to be asked is this – Are quality funds in the category of ultra-short, floating-rate and low-duration funds carrying dicey papers that could default – to the tune of more than 2%?

There’s been a rejuggling of portfolios. Whatever this number was, it has lessened.

The next question is, if push comes to shove, how differently are 100% AAA holdings going to be treated in comparison to compositions of – let’s say – 60% AAA, 30% AA and 10% A?

I do believe that a shock wave would throw both categories out of whack, since corporate AAA is still not sovereign debt, and the herd is not going to give it the same adulation. 

The impact of such shock wave to 100 % AAA will still be sizeable (though lesser) when compared to its cousin category with some AA and a slice of A. Does the 2% difference in returns now nullify the safety edge of 100% AAA?

Also, not all corporate AAA is “safe”. 

Then, if nobody’s lending to the lower rung in the ratings ladder, should such industry just pack up its bags? If the Government allows this to happen, it probably won’t get re-elected.

The decision to remain in this category encompassing ultra-short, floating-rate and low-duration bond mutual funds, or to switch to 100% AAA short-term liquid funds, is separated by a very thin line. 

Those who follow holdings and developments on a day to day basis, themselves or through their advisors, can still venture to stay in the former category. The day one feels uncomfortable enough, one can switch to 100% AAA. 

This brings us to the last questions in this piece. 

Why go through the whole rigmarole?

Pack up the bond segment for oneself?

Move completely to fixed deposits?

Fine.

Just a sec.

What happens if the government issues a writ disallowing breaking of FDs above a certain amount, in the future, at a time when you need your money the most?

Please don’t say that such a thing can’t happen.

Remember Yes bank?

What if FD breakage is disallowed for all banks, and you don’t have access to your funds, right when you need them?

Sure, of course it won’t happen. But what if it does?

You could flip the same kind of question towards me. What happens if the debt fund I’m in – whether ultra-short, or floating-rate, or low-duration, or liquid – what happens if the fund packs up?

My answer is – I’ve chosen quality. If quality packs up 100%, it’ll be a doomsday scenario, on which FDs will also be frozen dear (how do you know they won’t be?), and GILTs could well have a 10%+ down-day, and, such doomsday scenario could very probably bring a freeze on further redemptions from GILT too. When the sky is falling, no one’s a VIP.

Parked money needs to be safe-guarded as you would a child,…

…and,…

…there spring up question marks in all debt-market categories,…

…so,…

…as Equity players, where do we stand?

Keep traversing the jungle, avoiding pitfalls to the best of one’s ability. 

How long?

Till one is fully invested in Equity. 

Keep moving on. A few daggers will hit a portion of one’s parked funds. Think of this as slippage, or as opportunity-cost. 

Let’s try and limit the hit to as small a portion of one’s parked funds as possible. Let’s ignore what the herd is doing, make up our own mind, and be comfortable with whatever decision we are taking, before we implement the decision. Let’s use our common-sense. Let’s watch Debt. Watch it more than one would watch one’s Equity. Defeats the purpose of parking in this segment, I know. That’s why we wish to be 100% in Equity, parked or what have you, eventually. 

As we keep dodging and moving ahead, over time, the job will be done already.

We’re comfortable with the concept of being fully parked in Equity. 

Whereas the fear of losing even a very small portion of our principal in the segment of Debt might appear overwhelming to us, the idea of losing all of one’s capital in some stocks is not new for us Equity players. We have experienced it. We can deal with it. Why? Because in other stocks, we are going to make multiples, many multiples, over the long-term.

Equity seems to be the new normal for parking.