Credit risk is a constantly fluttering red flag for the market, as seasoned players will no doubt admit
Like an aria that loses its way in a parched wilderness, a good credit rating gets smothered by the overpowering impact of the many bad ones that typically surround it. Welcome to the world of creditworthiness (or the general lack of it), a theatre of war where a battle between haves and have-nots rages fiercely.
As recent events in the corporate sector reveal, not all seems to be well on the credit front. Witness the trouble that is believed to be brewing in various corners of the market, cutting across sectoral divides and inviting questions from distraught investors.
Credit risk is a constantly fluttering red flag for the market, as seasoned players will no doubt admit. The arrival of Covid, leading to constricted supply lines and followed by a host of related problems, has impacted many segments of the economy. A number of sectors are facing huge challenges even as you read this. Overall, inflation numbers do not look too healthy, a trend that has been fortified by the most recent acceleration in fuel prices, not to mention that of other commodities. In sum, these eat into corporate profitability and add to their bottom line problems.
Such pressure and its impact have been reflected in a general inability to service debt for a number of sectors. Borrowed funds must be returned to the loan provider—interest must be paid, and principal repaid. This is now a challenge for many; and at this juncture, it is not a pretty picture. That is the long and short of the debt scenario prevailing in the land.
The prevalence of poor creditworthiness is often attributed to what is popularly called “systemic flaws”. I must mention, these are not easily addressed, because many pockets of the corporate space still seem constricted. There have been, of course, several attempts by officials to redeem such sick pockets. The biggest effort of its kind is the creation of the appropriately named “Bad Bank”. This is a seemingly Herculean task: securing bad assets (`2 lakh crore in aggregate is being mentioned) and bringing them all under one roof. However, this may well appear to be a succour for the troubled credit sector, at least partially.
Be that as it may, the need for caution (insofar as credit risk is concerned) cannot be overstated. Investors, and I do include retail participants here as well, must exercise complete vigilance when it comes to assessing credit risk.
Strategy First
I wish to encourage investors to adopt a two-fold strategy in assessing credit risk.
A brief explanation should be useful. It is important—critical, really—to adhere to only AAA-rated papers or those that are rated just a notch lower. Safety and security are prime, in other words. This also means that you should keep away from riskier papers. All those AAs (or worse) are not for the faint-hearted. You must make sure that your portfolio bears the highest quality.
Next, do find out whether you can afford to keep off debt securities—that is, do not add to what you are already carrying on your shoulders. Well, the reason is not far to seek. Debt is, typically, low yielding for most people. At the end of the day, there seems to be no real satisfaction for the average debt investor. Not especially if you are comparing its returns with that furnished by equity at the moment.
I write this column at a time when the country’s central bank has for the eighth straight time not changed the key policy rate. Repo rate, as on October 8, 2021, (when the Reserve Bank of India made its announcement) remains at 4 per cent. As banking mavens will aver, the stance is accommodative.
Fine. Yet, doubts about inflation—the economy’s arch enemy—seem to persist. Clearly, we are bang in the middle of treacherous times. Commodity prices are accelerating. Fossil fuel, the big worry, is acting up. The fact that diesel and petrol are dearer has an impact on all sorts of costs. For the common man, food is considerably costlier today than, say, a year ago. Ditto for other essential items. That is true for medicines as well. Indeed, all kinds of user charges seem to be on the rise.
Allocation, The Next Big Thing
Today, of all days, across all seasons, allocation is supreme—ask any personal finance planner and you will get a common answer. Heads will nod sagaciously and the conclusion that you draw from it all will be simple yet overwhelming.
The common man operating in the debt market must allocate wisely in line with his risk profile. If the investor can accommodate some measure of risk, he must go ahead and shoot. Else, he needs to stay invested in base-level debt options. Yes, I know it will be somewhat upsetting as these will not perform in any meaningful way. What is the point in getting 4-6 per cent return in today’s world? You can surely ask yourself this question. The answer is evident too.
It, therefore, is quite evident that allocation must be kept dynamic. If you are not very sure, or if you do not wish to adopt a DIY stance, go to professional fund managers and take their advice.
Perhaps you can place a strategic part of your portfolio in carefully-chosen equity assets. And when the time is right, shift it all (or gradually, depending on your strategy) to debt. Or, keep altering the weightages in keeping with contemporary market trends.
Now, if indeed you have gone to fund management companies, try to look up a product category called “balanced advantage”. The very name will reveal to you the inside story. The “balanced” bit here implies hybrid—a prudent mix of debt and equity. As for the second part of the name, “advantage”, I leave it for the investor to assess the situation.
Find out more about this; do a bit of digging if you have to. You have formidable enemies, remember. To reiterate, inflation and income tax are your worst foes. And to top it all, there is credit risk. With some patience and luck, not to mention diligence, you should be able to choose well. Let a sweet aria work its way through the dry wilderness. It will no doubt be pleasing to your senses.
The author is Director, Wishlist Capital