Tag: fixed income

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Editorial

Why Are Gold Prices Falling After Touching A Record High last September?

source: shutterstock

In September 2020, gold prices touched a record high of Rs 58,000 per 10 gram. In times of crisis and uncertainty, people tend to buy more gold as it is a risk-haven and comparatively less volatile. There were many reasons why gold prices hit record highs in 2020. The US-China Trade War, negative US bond yield, geopolitical tensions, and uncertainty around the COVID-19 pandemic to name a few. 

Fast-forward to a few months later, gold prices have come down significantly to a 10 month low. As of 6th April 2020, gold is trading close to Rs 45,500 per 10-gram level, which is around Rs 13,000 less than the record high of Rs 58,000. The way the gold prices were soaring, a correction was definitely expected but there is much more to it. There are some economic factors, market factors, and other global factors that have come into play. 

Reason 1: Investors Have More Risk Appetite

During the COVID-19 lockdown, businesses were shut, unemployment was high, global economies were down, households did not have money to spend and had to depend on government support for expenses.

Once things were a little better, governments all across the world release stimulus packages. Central banks across the world reduced interest rates to put money into the system. Loans were offered at low-interest rates and moratoriums were given on NPAs. All of a sudden, markets were flooded with liquidity.

Gold, on one hand, is a risk haven. People invest in gold during times of uncertainty, since gold is globally accepted and can be sold during times of crisis.  When there is too much money in people’s hands, they are likely to invest it in more risky assets. The stock market is one of them. The global stock markets managed to touch record highs. NIFTY and SENSEX touched their record highs as well.

Reason 2: Dollar Zooming 

For the past few years, gold and the US Dollar have had an inverse relationship. The current increase in the US dollar with respect to other global currencies has caused gold prices to decrease. This is because if the US dollar becomes stronger, gold will become relatively more expensive in other currencies causing demand to reduce and therefore the price. Conversely, if the US dollar gets weaker, gold becomes relatively cheaper to buy in other currencies, and the demand increases, and therefore the price. However, it must be noted that gold and the US dollar CAN move together in some cases. 

Reason 3: Rising Bond Yield

In August 2020, the US 10-Year bond yield was ~0.52%. The yield has now risen threefold to ~1.6% in March 2020. When bonds return a higher yield, the cost of holding gold becomes higher. Investors will prefer holding stocks and bonds over gold, as these would give a better return than gold. Investors will start diluting their gold holdings and start pouring that money into the bond and stock market. This will cause gold prices to decline.

Reason 4: India cuts custom duty from 12.5% to 7.5%

In the 2021 Budget Session, the import duties on gold were slashed from earlier 12% to 7.5%. An additional 2.5% cess was proposed in the form of Agricultural and Infrastructure Development Cess(AIDC). After the announcement, gold futures on MCX slumped 3% or about ₹1,500 per 10 gram.

The decrease in gold prices has seen a lot of accumulation happening which helped in price recovery. Prices are up by almost Rs 2000-Rs 2500 from the low of Rs. 45,500 per 10 gm. The second wave of COVID-19, rising lockdown measures, uncertainties over vaccines, rising debt, and liquidity are supporting factors of gold price rise. A question remains, should you invest in bonds over gold? The US 10-year bond yield has been at its peak recently, bond prices are low, yields are high. One can either choose to profit from the volatility of the gold market or choose to invest in a rather consistent instrument like bonds. Investors should watch out for inflation numbers, long-term bond yields, US Fed Reserve Rate, and other global factors that might affect the spot price of gold. 

So the next time you see a family member wondering why gold prices are moving like it is, you will know the answer!

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Editorial

How Does Your Provident Fund Work? Does the Employees’ Provident Fund Lack Transparency?

Are you a salaried individual? Do you avoid investing in shares and bonds thinking they are quite risky? You might not know but you are unwittingly investing in them through your Provident Fund. That’s right, the Employees’ Provident Fund Organization or EPFO  is required to invest up to 15% of its corpus in the equity markets. The remaining 85% is invested in Fixed Income instruments like Bonds, Treasury Yields, Government Bonds, etc. 

So how exactly does your Provident Fund work? Does it lack Transparency and Efficiency?

The Concept Of Provident Fund

In a provident fund, you give a portion of your salary to the EPFO, your employer also contributes a similar amount to the EPFO. The EPFO then invests that money over a long period, in bonds, equities, and other securities and multiplies the money. By the end of a few years, depending on when you choose to withdraw your money from your Provident Fund, you get your principal amount, plus the interest rate applicable on principal. The interest rate keeps changing and is decided by a Central Board. Currently, the interest rate applicable is 8.5% per annum as of FY2021.  

One can claim their Provident Fund after only retirement or a certain period of unemployment. As of 2021, one can withdraw PF after Unemployment for 1-2 months. 75% of EPF can be withdrawn after unemployment of 1 month of unemployment. The remaining 25% can be withdrawn after 2 months of unemployment. One can also withdraw before retirement in case of purchase of flat/house/site, the marriage of dependents in family/self or for medical expenses or during a natural calamity or emergency. 

Where Is The Provident Fund Money Invested?

The total Assets Under Management(AUM) by EPFO is close to Rs 11 lakh crore. Employees if EPFO isn’t well-trained finance professionals and may not be apt to handle such huge amounts of money. Therefore, EPFO hires fund managers, organizations like SBI, UTI, ICICI, and other well-known organizations to manage their funds and invest in markets. In 2019, EPFO appointed SBI Mutual Fund and UTI Asset Management Company as its fund managers for a period of three years. These fund managers on behalf of EPFO invest their corpus in Exchange Traded Funds(ETFs) and Fixed Income instruments. EPFO does not invest directly in shares and equities of individual companies, rather in ETFs. EPFO invests in SBI Mutual Funds, UTI ETFs, CPSE ETF, and Bharat 22 ETF. 

To Know More About Exchange Traded Funds(ETFs), Click Here.

Provident Fund and COVID-19

EPFO lost money with the onset of the COVID-19 pandemic. In March 2020, there was a huge selloff in markets with the onset of the COVID-19 pandemic. The COVID-19 lockdown added to the injury. Naturally so, as people lost employment, they had to depend on savings and provident fund money to survive. Provident Fund withdrawals rose. EPFO closed 71.01 lakh EPF accounts between April 2020 and December 2020. 

Right after the lockdown was announced in March, the government allowed subscribers to withdraw an amount not exceeding their three months’ basic pay and dearness allowance from their EPF accounts. Due to COVID-19, the EPFO settled 60.88 lakh withdrawal claims and disbursed  ~Rs 15,255 crore till January 31, 2021. 

Post lockdown, EPFO data is now an indicator of a recovering economy. It managed to add 12.54 lakh subscribers in December 2020 and 13.36 lakh subscribers in January 2021. This is a ~28% percent increase in net subscribers YoY. EPFO added close to 2.61 lakh female subscribers in January, which is 30% more than the previous month. 

Does EPFO Need To Diversify and Be More Transparent?

The asset allocation of the EPFO corpus is pretty opaque. Nobody knows where the money goes to or where the money comes from. An average PF account holder doesn’t know where the money is going. Quite a fraction of this information is in the public domain. There have been instances where senior economists have suggested that EPFO must become transparent and diverse when it comes to investments. In public opinion, Bharat 22 and CPSE ETFs have been deemed not appropriate for a pension fund like EPFO. Moreover, these funds haven’t yielded great returns either. The government is aiming to restructure the EPFO with the creation of a separate cadre of officers for it and bringing financial expertise into the organization. Do you find EPFO to be a poorly managed organization? Let us know in the comment section in the marketfeed app.

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Jargons

What are Municipal Bonds?

Municipal Bonds or Muni Bonds are bonds issued by local government bodies or Municipal Corporations. Bangalore was the first city to issue municipal bonds in India in 1997. Later, Ahmedabad followed by launching its municipal bonds in 1998. The funds raised by these municipal bonds are used for constructing bridges, parks, schools, and other public projects. Are these bonds safe? When should one invest in these bonds? What are the risks associated with these bonds? Let’s find out!

Why Do Local Bodies Need Bonds? 

Urban Local Bodies, like municipal corporations, public townships, etc. have always had a lack of funding and resources. According to a 2018 report by NITI Aayog, “The total revenues of all Urban Local Bodies (ULBs) in India amount to less than Rs 1, 50,000 crores, approximately, 1% of India’s GDP.”  

Most of the municipal corporations rely on grants or budgets allocated by state governments or the central government. Apart from these, they rely on water supply bills, property taxes, octroi, rents from municipal properties, vehicle registration fees, etc. The municipal bodies also had the responsibility of promoting socio-economic development in their areas. However, these are not sufficient to set up new projects or maintain already existing projects. To address this problem, local bodies started issuing municipal bonds. 

How Good Are Municipal Bonds?

  • Tax-Free Income- Municipal bonds are usually tax-free or taxed at a lower rate. It is advisable to check the placement memorandum and necessary paperwork before investing in a bond.
  • Lower Risk – Municipal corporations of big cities set up projects like metro rails, public transport, roads, flyovers, public parking spaces, gardens, redevelopment schemes, and housing schemes. These big municipal corporations are likely to recover the money that they spend. Such development is seen only in Tier-1 and Tier-2 cities and generally gave a credit rating above A- going up to AA+ which is actually good. 

    On the other hand, municipal bonds of smaller towns and cities tend to have fewer development projects in hand and therefore might depend on taxes collected to pay back their bondholders. This means that the returns might get riskier for smaller municipal corporations. These bonds have a credit rating lower than BBB+.
  • Strict SEBI Regulations- SEBI guidelines have assured that only those municipal bodies that are financially stable and have the ability to pay back their bondholders can issue bonds. You can read the official SEBI guidelines for municipal bonds over here.
  • Lower Default Rate – On average, municipal bonds have a default rate of 0.18% as compared to corporate bonds which have an average default rate of 3%. This means that municipal bonds are more likely to pay back an investor’s money.  

How Risky are Municipal Bonds?

  • Long Maturity Period – Most Municipal Bonds are issued for 10 years and generally start paying out after the 4th year from the date of issue. This means that Municipal Bonds may not be the best idea for those wanting to invest short term. 
  • Lower Returns – Municipal bonds offer a lower rate of return than corporate bonds due to various reasons like limited revenue base, tax base and risk factors. 
  • Call Risk – Like how companies ‘buy-back’ shares, bonds are ‘called’ back. Companies do so when the bond yield decreases and they want to increase the yield to attract more investors. When these bonds are ‘called’, they pay the bondholders the face value of the bond and the interest accrued on it.  This can cause the bondholder to lose potential interest or pay more taxes on the amount received. 
  • Dependence on Third Parties – Municipal projects aren’t the cleanest in nature. There is a lot of corruption and third parties (contractors) involved who may try to cut corners on the projects. Whether or not a project is completed depends on the company to whom the project was tendered to. 
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Jargons

What Are Bonds? Types of Bonds, Risks and Jargons

What Are Bonds?

A bond is a fixed-income security that a company or a government uses to raise money for a given period of time. In simple words, an organisation can raise debt/borrow money from investors (Mutual Funds, Foreign Investors, Domestic Investors, etc.). Bonds are low-risk investments that give fixed returns to an investor over a period of time. 

Bonds are less riskier than shares, provide a higher return than bank deposits and certain bonds are even tax-free or are charged less tax than other instruments. Bondholders hold a greater preference than shareholders in a company. This means that in case a company shuts down, the bondholders will get their money before the common shareholders do.

Companies on the other hand prefer issuing bonds than borrowing money from the bank. This is because they may require strong financials, cash flows, and credit profiles, without which banks may not lend money. In bonds, it is completely at the investor’s discretion to invest money in those which abide by certain guidelines issued by SEBI and RBI.

Some Important Jargons

  • Face Value/Par Value- The price or value of a single unit of bond when it is first issued. However, it can be traded at below or above its face value/par value.
  • Premium and Discount- If a bond is traded at a price above its face value, it is said to be at a premium. If a bond is traded at a price below its face value, It is said to be at a discount.
  • The Principal or Par Amount- The total amount invested in a particular bond. 
  • Maturity Date- The expiry date of a bond when the bondholder will get back the principal amount along with interest if any.
  • Coupon Rate- It is the rate of interest payable at a fixed interval till the expiry date (Annually, Semi-Annually, Quarterly).
  • Yield- Coupon Payment or Interest Payment received over one year divided by the face value of the bond. Example: If the face value of a bond is Rs.100 and the interest payment received is Rs.10, then the yield is 10%.
  • Yield To Maturity– Yield To Maturity or YTM is the total expected return for an investor if the bond is held till the maturity date.  

Factors Affecting Bond Prices and Yield

  • Market Interest Rates – When the market interest rates decrease, the price of the bond increases. Let us take an example: If the rest of the market is providing returns at 2% interest and the bond meanwhile is providing 4% returns, then more people would invest in the bond than the rest of the market, and this will increase its demand and its market price simultaneously. When market interest rates increase then the price of the bond decreases. 
  • Inflation – When inflation increases, the buying power of the interest earned also decreases. For example- If a bond pays 4% interest annually, and the inflation increases from 0% to 2% in a year, then the real return earned would be 4% minus 2%, which would be 2%. So the ACTUAL return received would be just 2%.
  • Credit Rating – Based on a company’s performance, its risk, and other factors, Credit Rating Agencies like Flitch and Moody’s rate the bonds according to their risk profile. The riskier the bonds, the lesser is its market price as very few would invest in them.

Types of Bonds

Bonds can be classified into many types based on the requirements of the investor. The bond market is an extremely diverse market with hundreds of different products. Not all bonds have a fixed coupon rate and Not all bonds provide regular coupon payouts. Mainly, Bonds are classified according to their issuer, the coupon rate, purpose, currency, country of origin, and much more. 

Broadly speaking, based on the issue of the bonds, they can be classified as follows:

  • Government Bonds- Bonds issued by the state or central government 
  • Corporate Bonds- Bonds issued by private companies
  • Municipal Bonds- Bonds issued by local governments or municipal corporation
  • PSU Bonds- Bonds issued by Public Sector Undertaking such as SBI, ONGC, etc.

Risks Associated with Fixed Income Securities

Inflation risk – that an increase in inflation might reduce the buying power of the returns received on the security. 

Interest rate risk – that increase in overall interest rates shall occur which in turn will decrease the price of the bonds. 

Currency risk – that exchange rates with other currencies will change during the security’s term, causing loss of buying power in other countries

Default risk – that the issuer will be unable to pay the scheduled interest payments or principal repayment due to financial hardship or otherwise

Example

Let us say, a company, Spanners Pvt. Ltd. manufactures nuts, bolds, and spanners. They wish to set up a new factory in Bangalore, but they do not have the sufficient capital required to set up the new factory. Spanners Pvt Ltd. decided to issue bonds of face value Rs 1000 per unit, with a coupon rate of Rs 100 paid half-yearly for a period of 10 years.

Kumar is a computer programmer with savings of Rs 10000. He wants to invest 50% of his savings (Rs 5000) in less risky investments. He does not want to invest in bank fixed deposits (FD) since he feels that they do not pay much interest and are illiquid. Kumar decides to buy 5 bonds of Spanners Pvt. Ltd for a par value or principal of – Rs.1000 x 5 Bonds – Rs. 5000. 

10 years later, Spanners Pvt. Ltd has become a big company and now it’s time to pay its bondholders. Since Kumar has earned Rs 100 every 6 months as a coupon payout for 10 years, he has earned – Rs 100 x 2 times a year x 10 years – which equals to Rs.2000. Meanwhile, Kumar also gets his principal or par value back which is – Rs.1000 x 5 Bonds – Rs.5000.

In 10 years’ time, Kumar invested Rs 5000 and got back Rs 7000 making a total profit of Rs 2000. 

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Jargons

What are Fixed Income Securities?

rupee note on laptop

Fixed income securities are a group of debt instruments that provide fixed returns. These can be in the form of regular interest payments or repayments of the principal when the security reaches maturity. They are issued by a government, corporation, or other entity to finance and expand their operations. Investors in fixed-income securities are typically looking for a secure return on their investment.

Types of Fixed Income Securities

  • Bonds – Governments and Corporations(Issuer) issue bonds to the market (general public, mutual funds, etc.) in order to raise money to fund their projects. The issuer promises to pay back the principal amount invested in the bond along with the interest payable at regular intervals.
  • Fixed and Recurring Deposits – You are probably familiar with these terms. Fixed and recurring deposits with a bank give a certain rate of interest. They can help save tax if invested for a long period of time.
  • Company Fixed Deposits – Company Fixed Deposits are offered by Financial and Non-Banking financial companies (NBFCs). The deposit is placed by investors with companies for a fixed term carrying a prescribed rate of interest
  • Fixed Maturity Plans or FMPs– FMPs are close-ended debt mutual funds with a pre-determined tenure and rate of return. Their maturity period can be from 1 month to 5 years
  • National Savings Certificate-The National Savings Certificate (NSC) is a fixed-income investment scheme that you can open with any post office. As a government-backed tax-saving scheme, the principal invested in NSC qualifies for tax savings under Section 80C of the Income Tax Act up to Rs 1.5 lakhs annually.
  • National Pension Scheme – The National Pension Scheme is a social security initiative by the Central Government. This pension programme is open to employees from the public, private, and even the unorganised sectors except those from the armed forces.
  • Treasury Bills or Government Securities

Risks Associated with Fixed Income Securities

  • Inflation risk – that the buying power of the principal and interest payments will decline during the term of the security
  • Interest rate risk – that overall interest rates will change from the levels available when the security is sold, causing an opportunity cost
  • Currency risk – that exchange rates with other currencies will change during the security’s term, causing a loss of buying power in other countries
  • Default risk – that the issuer will be unable to pay the scheduled interest payments or principal repayment due to financial hardship or otherwise

More On Fixed Income Securities

There are many fixed-income derivatives such as interest derivatives, credit risk derivatives, etc. There are many fixed income products such as Bonds ETF and Debt Mutual Funds. These fixed income instruments are for ones who have a low-risk appetite and want a fixed regular income.

If an investor isn’t able to conveniently able to liquidate or monetise when the need arises, that would make it a bad decision. Fixed Income Investors need to give weightage to their priorities and needs over the rate of return since most fixed income securities have a prolonged maturity period.

One needs to know that fixed-income products aren’t bullet-proof and they have their own risks attached to them. To read more on how Franklin Templeton had to shut its six debt mutual funds, click here.