Investors like bonds because they feel that they are safer than equities and get regular income. But bonds offer little transparency in a world where risk information is intentionally distorted
The actions of the central banks have certainly encouraged the bond market. This has been true since the former US Federal Reserve chairman, Alan Greenspan’s program to intervene in markets when they were falling, but not when they were rising. The interest rate suppression of the so called “Greenspan put” encouraged steady growth, but a huge increase in debt. Hyman Minsky, an American economist, argued that an overleveraged situation does not require excessive optimism, merely excessive certitude in that interest rates will not go up. This eventually leads to the dreaded “Minsky moment”, a crash following speculation using borrowed money. Ben Bernanke, Greenspan’s successor, isn’t worried. He has outdone his predecessor in distorting the markets’ price discovery mechanism by encouraging risky assets including a massive increase in debt.
With historically low yields it makes sense for anyone who can borrow to do so. The result has been record issuances of corporate, municipal and sovereign bonds. So far this year bond issuance in Europe and the US has been $570 billion—on par with the peak five years ago. The new issues are on top of another record. The total number of bonds outstanding has almost doubled in size from a year ago from $5 trillion in 2008 to $9.2 trillion in 2012.
Interest rate suppression has led to the hunt for yield benefiting emerging market sovereign debt. This has led to some rather strange risk assessments. For example compare the sovereign debt of Spain with the Philippines. Philippines bonds are priced in pesos. Spanish bonds are priced in Euros. Philippines rank on the Doing Business index is 135. Spain is ranked at 44. Spain is the 12th largest economy in the world. Philippines economy is only 14% of Spain's. On the corruption index Philippines is ranked at 105. Spain is ranked at 30. Spain still has an investment grade credit rating of Baa3. Philippines is below investment grade at Ba1. Spain can be bailed out by the ECB (European Central Bank). The Philippines is on its own. Yet the market ranks Philippines as a much safer place to invest. Its ten year bonds yield 4.19%. Spain's 10 year bonds are priced at 5.45%. Credit default swap for Philippines debt is only a 100 basis points down from 800 in 2008. Spanish swaps are triple the price at 311.
The $4 trillion US municipal bond market has also been extremely popular. Investors have bought so many that yields are the lowest in 45 years. But much of the money flowing into municipal bonds is into the riskier high yield bonds. The high-yield municipal funds account for less than 11% of the assets in US municipal bond funds, but for more than 20% of the $42 billion of cash that flowed to municipal bond funds this year. This choice could ultimately prove to be ill-advised. Credit rating agency Fitch warned that US local governments are still far from a recovery. The agency expects to downgrade dozens or hundreds of issuers in 2013.
With all of the corporate bonds being issued it is not surprising that there has been a flood of junk bonds. Part of the problem is that the market has learned little; since 30% of these bonds are “cov lite” in that they have few terms. These are the exactly the same bonds that caused so much damage in 2008. Worse, selling the bonds may be far more difficult than buying them. The weekly trading volume for bonds in the US has declined from $266 billion in 2007 to $90 billion this year, while the market has grown from $2.5 trillion to $3.7 trillion.
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Private equity firms used to realize on their investments by going public and cashing out. That is no longer necessary. These days they just leverage up the companies by selling debt and make payouts as dividends to the buyout groups. Some of these bonds are the infamous PIK bonds, or payment in kind. These allow the companies to make interest payments with more debt. These bonds have a 13% default rate, twice the normal level.
To read Moneylife research analysis on fixed income instruments, click here.
Potential issues with corporate bonds are not limited to developed countries. In China the government worried that real estate prices were too high, so they implemented a series of restrictions including access to bank loans. Local governments, whose revenue depends on land sales and developers, found ways around the restriction including selling bonds to sovereign wealth funds, hedge funds and banks. The bonds pay high interest rates, but they have little transparency. But prices are rising again, so the government may decide crack down on excessive development which would threaten the issuers’ solvency.
Investors like bonds because they feel that they are safer than equities. But in a world where risk information is intentionally distorted, they may want to rethink their assumptions or discover that Minsky was right.
To read other articles written by William Gamble, please click here.
(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and has spoken four languages.)
The strength of a regulation lies in the clarity that it provides to the common man. How does SEBI’s regulation on mis-selling of mutual funds score on this count?
There is good news for mutual fund investors. The Securities and Exchange Board of India (SEBI) has brought mis-selling of mutual funds under the ambit of fraudulent trade practices. But there is a bad news as well. Mis-selling as a concept probably still requires as many clarifications as it did before SEBI decided to make mis-selling as a part of fraudulent trade practices. SEBI has defined mis-selling as the sale of units of a mutual fund scheme by any person, directly or indirectly, by
(i) making a false or misleading statement, or
(ii) concealing or omitting material facts of the scheme, or
(iii) concealing the associated risk factors of the scheme, or
(iv) not taking reasonable care to ensure suitability of the scheme to the buyer
Let us try to understand and interpret all the four scenarios of mis-selling as defined by SEBI.
The first clause says that making a false or misleading statement to an investor is a fraudulent trade practice. Let us take an example to analyse the scope of the statement. If a mutual fund scheme has given an average return of 15% during last five years with as high as 40% return in one single year and the agent selling mutual fund says that the scheme can give 40% return to the investor, will it be interpreted as mis-selling? Is the statement false or misleading? On the face of it, the agent is making statement based on the past performance but he is also creating an impression which may not be right, as past performances cannot be repeated in future. This statement may lure an investor to invest into the scheme.
Similarly if a mutual fund scheme has given positive returns during the last five years when the benchmark index, Sensex, gave negative return and the mutual fund distributor says that the scheme gives positive return irrespective of performance of Sensex, will it be interpreted as mis-selling based on false or mis-leading statement? Logically the distributor sounds correct but is it not again mis-selling? If this is mis-selling then how can a distributor pitch such good schemes of mutual funds?
As regards the second clause to identify mis-selling, the meaning of the word “material facts” need to be interpreted first. Material fact is generally defined as, “A fact that would be important to a reasonable person in deciding whether to engage or not to engage in a particular transaction; an important fact as distinguished from some unimportant or trivial detail”. What is material in context of a mutual fund schemes? An equity mutual fund is a mutual fund which should have invested more 65% of total corpus in equity shares of companies. An investor asking for a equity mutual fund is suggested a mutual fund which has invested 65.5% of its corpus in equity shares of companies and 33% in debt. Will 33% of debt be considered as material and can the investor claim that he was offered a scheme which has a sizeable corpus invested in debt contrary to what he was looking for and he has made investment in the scheme based on recommendations of the distributor?
Similarly, associated risk factors of the scheme are very broad and varied and in absence of clear-cut distinction it will be difficult to identify what will be classify as the associated risk factor. However, the most important aspect of the regulation which says that not taking reasonable care to ensure suitability of the scheme to the buyer is a fraud indeed requires elaboration. Can selling an equity scheme to a risk averse customer be treated as mis-selling as equity schemes are not suitable for customers who wish to avoid risk?
It is true that all regulations are ultimately subject to judicial interpretations but strength of a regulation lies in the clarity that it provides to the common man. We will have to wait and watch to see how things unfold in future with respect to this regulation. Also will mis-selling stop or will this regulation again be an example of a half empty glass which is also a half full glass as far as interpretation goes.
To read more from Vivek Sharma, click here.
(Vivek Sharma has worked for 17 years in the stock market, debt market and banking. He is a post graduate in Economics and MBA in Finance. He writes on personal finance and economics and is invited as an expert on personal finance shows.)
The report 'Envisioning the Next Telecom Revolution' by FICCI, DoT and AT Kearney, attributed the decline in ARPU to rapidly evolving technology environment and increased cost to support improved customer service offerings
New Delhi: The average revenues per user (ARPU) of mobile operators have declined by up to 24% during 2008 and 2011 due to increased cost to support customer service, reports PTI quoting from a study.
"ARPU (average revenues per user) for GSM operators declined at an average compounded annual growth rate (CAGR) of about 24% between 2008 and 2011, while for CDMA operators ARPU fell at a CAGR of 13% during the same period," said a report 'Envisioning the Next Telecom Revolution' by FICCI, DoT and AT Kearney.
It attributed the decline in ARPU to "rapidly evolving technology environment and increased cost to support improved customer service offerings".
It added that competition in the Indian wireless market is amongst the highest globally. Compared to other emerging markets, the number of wireless network operators in the country far exceeds that of China, Brazil, Russia or Korea, the study said.
The largest Indian operator has 20% of subscriber market share and the top three operators cumulatively have less than 50% market share, said the report. In contrast, other emerging markets have at least 80% of the market share cornered by the top three operators, it added.
"While the stiff competition has been of advantage to Indian consumers making wireless services more affordable, it has made the ROI (return on investment) task challenging for operators," the report said.
The Indian telecom sector witnessed revenue stagnation in FY2010 and FY2011 due to high intense competition, it said.
"The situation improved partially in FY2012, and revenue growth continues to be strong in the current financial year," it said.
The report said non-voice revenues of mobile operators will increase to 27% by 2015 from 14% in 2011, of which about 15-20% will come from mobile data, which is expected to grow at 126%.
The voice revenues will decrease to 73% from 86% during the same period.
"Proliferation of smart devices is accelerating this shift towards data. In 2008, only 3.8% of handsets sold in India were smart phones. By 2011, this had increased to 8.1% and is further expected to grow to 25% by 2016," the report said.