Learnings of the Week-2. (1/2)

Deepak shenoy on debt mutual funds and current situation

  • Most people think of mutual funds as equity but obviously there’s debt as well. More than 50% of all mutual funds are debt. So roughly 25 lakh crores is in mutual funds as of Mar 31, 2020.13 lakh crores of that – a bit more than 50% – is in debt mutual funds
  • From 150 lakh crore total money supply, half is in FDs which is 73 lakh crores
  • FD market is roughly 6 times the size of the debt mutual fund market (including debt fund who invested in FDs)

What is the purpose to invest in debt funds instead of FDs?

  • One can’t get some amount of money back after making an FD, and he/she is in need of money, he/she have to break the FD and will lose interest, but at a mutual fund, one can sell their MF unit when they need money
  • People want liquidity and want to park for short term, which can’t be served by FDs
  • Another benefit in debt mutual fund is they provide compounding; debt funds invest in debt instruments and they reinvest earned interest again in instruments and thus provide compounding to us, which you can observe if you stay with the fund for more than 3 years, FD give simple interest only, and moreover by staying more than 3 years with debt fund make you pay 80% less taxes all around
  • In short, debt fund can give the same rates like FDs with more liquidity, compounding of interest and tax efficiency

Which types are there in debt funds and in which to invest?

  • Let’s see debt funds type and their maturities
    • Liquid and overnight funds – 3 days
    • Liquid fund – 3 month
    • Ultra-short-term funds – 3 to 6 month
    • Low duration fund – 6 to 12 month
    • Money market fund – 1 year, invest in commercial papers and certificate of deposit
  • Then you can go into specific kinds;
    • Corporate funds – lend to AAA or AA rated corporate (maturity 3 month to 5 years)
    • Credit risk fund – lend to stuff less than AA
  • You have to allocate yourself where are comfortable according to your mindset and needs

Which are verities in which MF invests?

  • Sometimes they directly lend money to corporates
  • Sometimes they invest in corporate debt from the secondary market where they can get bonds at a low rate
  • If you directly invest in government bonds or t- bills, you have to pay tax, but you can invest in funds who invest in those securities
  • You are giving your money to the fund because RIL bond is giving 10% and you want it, sorry but fund don’t invest your money every time when you give it
  • When there is more redemption (outflow) than inflow for fund, the fund is not a buyer, but it is seller as it has to pay for redemptions
  • Buying an MF does not mean your money is directly participating in the marketing. You have to be aware of this

Why there’s a big gap between the actual liquidity of the things that debt mutual funds invest in and the liquidity that’s promised to a customer

  • Let’s say it is ultra-short-term fund who invests in 3 to 6-month maturity securities
  • Now they have invested in corporate funds 5 year maturing debt product, which is floating rate bond and update interest rate every 6 months
  • According to funds, the interest rate is resetting every 6 months so the maximum duration is 6 months for the purpose of calculation
  • So, fund have a 5-year product but still showing it like 6 months to us
  • Funds sometimes invests in unlisted bonds which are illiquid
  • Let’s say fund have 10% in these bonds, when there is redemption, fund can’t sell these bonds but have to sell good one to pay and these bonds become let’s say 20% of fund, which creates disaster at the time of slowdown
  • Funds sometimes invest in company which is not worthy but they do it because another company’s promoter is managing it and he gives you his shares as collateral and issues cumulative bond
  • After the maturity, when fund go for repayment, promoter simply issue newer bonds to repay older one

Is this liquidity issue also happen with FDs?

  • Generally, no because,
    • FDs have 20% money in government bonds
    • There is RBI for banks who can lend money to bank in case of any issue
    • There is RBI who guarantees that it will protect depositors and won’t let banks down
  • Liquidity right now is much better in banks than in mutual funds because they have a lender of last report, MF don’t
  • Yes, RBI have told bank to help MFs by giving 50,000 crores, but not all the time
  • Today mutual fund is seller and not going to roll over any debt, so companies who were taking loan from mutual fund at 6% have to now borrow from banks at 8% or 9%
  • This will ruin their margins and will put them in great stress
  • Hence, we can say RBI have to help companies if the situation become worse

Article link:
https://www.capitalmind.in/2020/05/podcast-27-the-run-on-debt-mutual-funds-is-your-money-safe/

Who should bear the losses?

  • Coronavirus paramedic is banging on and number of victims are unlikely to fall to zero
  • Companies are having loss of income and they also have to pay their debt, hence they are in great trouble
  • This effect hasn’t any limited sector and is causing many companies in many industries
  • As well as companies, the government is also going to book a loss, both from tax collection part and expenses part which it is doing for health care and managing the pandemic

So, who is going to bear these losses?

  • Government itself should come upfront to absorb these losses because, if it doesn’t come now, companies will have great impact, which can cause consumption as employees will also have impact
  • If companies started defaulting, it will be worst for financial system of the country
  • And at last, the government will have to come for rescue

So, in current circumstances, we will be looking for government’s rescue plan before trouble converted into a disaster

Article link:
https://twitter.com/neelkanthmishra/status/1257836711670804481?s=08

The non-bailout: How the fed saved Boeing without paying a dime

  • Before 2 months ago Boeing company went to the US, asking for $60 billion bailouts for itself and its suppliers
  • Boeing has spent heavily on buyback and also fighting with 737 max disaster were not able to get govt support
  • By urging the fed reserve, the Trump administration ended up helping the plane-maker more than any government handout could
  • Fed decide to purchase the corporate bonds, as it has limitless balance sheet, result in improved liquidity and become game-changer for the company, but the company is not allowed to speak publicly because they aren’t authorized
  • Just weeks earlier, President Donald Trump’s former ambassador to the United Nations, resigned from the company’s board in protest. Other critics were quick to argue the government could better spend its funds
  • Govt around the world invested around 100 billion dollar keeping airlines afloat, giving assurance that there will be buyers for Boeing aeroplanes when the outbreaks abate
  • Boeing entered to raise 10 billons to 15 billion dollars by selling bonds with maturities of 40 year
  • But due to high demand, they set the final size of the deal to $25 billion, turning it into the largest U.S. corporate bond sale of the year

Boeing hasn’t closed the door to seeking federal aid in the future, especially given the risk the pandemic may again cripple travel and economies later this year

Article link:
https://www.bloomberg.com/amp/news/articles/2020-05-02/the-non-bailout-how-the-fed-saved-boeing-without-paying-a-dime?__twitter_impression=true

Published by Aakash and Meet

I am Aakash Raotole I am currently doing Bcom from Dr. Patel and Rb Patel commerce college I am currently studying at finnacle investment academy Recently done distance internship with windrose capital, Pune - for a period of 14 weeks I am Meet Bhatt Completed HSC in commerce Now studying finbridge program at finnacle investment academy and Bcom externals I had completed CFA institute's investment foundation course and distance internship with Windrose capital, Pune - for a period of 14 weeks

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