Should Gentlemen Prefer Bonds?

There is this fixed income theme playing in my contrarian head since some time and I did some priliminary reading over the past few days to figure it out. The hike in diesel will surely stoke inflation, but much depends on how the INR will behave as the US Fed goes about mopping mortage securities from the US market. The USD has already started depcreciating post the QE3 announcement. The JPY will also join the party now that the central bank of Japan has also announced their own mop up act. Yes, the fact is that global events will always have a much higher impact on the landed cost of fuel (huge component of inflation) than the price cuts announced. It is perhaps because of this ‘imported inflation’ that the RBI chose not to dunk their policy rates (repo) despite the industry clamouring for it like a starving mongrel. Ergo yields remain high and the hypothesis that once the policy rates get lowered (step wise), fixed income trading positions will profit is still yet to be proven.

Peter Lynch’s quote comes to mind:

When yields on long term Government bonds exceed the dividend yield on the S&P 500 by 6% or more, sell your stocks and buy bonds.

Now, I don’t know how much of this still applies in the US markets as of today, let alone India but the chart below shows the historical trend of the dividend yield of the NIFTY over the past 13 years or so.


The 10 yr GoI bond yield has been moving in a range bound manner since the start of last calendar yield (see chart below from Bloombeg). It is around 8.18% these days. So, Lynch’s above equation evaluates to 8.18% – 1.48% = 6.7% > 6%.

But then yet another quote from Peter Lynch comes to mind and makes me all confused as ever:

Gentlemen who prefer bonds don’t know what they are missing


Progress Through ReGrESS

Middle men have always blocked new ideas and won reconciliatory middle ground in India. The inclusion of ETFs in the Rajiv Gandhi Equity Savings Scheme (RGESS) is one such example. While the matter of the difference of opinion between the Finance Ministry and the Securities and Exchange Board of India (SEBI) is interesting, the development is noteworthy since it could benefit us retail rats quite a lot.

 The thing is that equity remains shunned as an asset class by an overwhelming majority of small investors in 5% – 7% growing emerging India. Whatever little money does get invested goes into managed funds finds its way into the Mutual Fund coffers. ETFs offer a long term, cost efficient vehicle for parking money and are quite cheaper as compared to Mutual Funds. So if the retail rats don’t get it, why shouldn’t the Government play pied piper and lead them to the bourses. It certainly helps that the current Finance Minister (Chidambaram) is more taken to the merits of equity as compared to his predecessor. A part of him may even secretly look at the market levels as a barometer for his success.

 It’s also a great idea to pool in slivers of equity from profitable PSUs, bundle them into an ETF and offer it to investors. That way you don’t have to do an IPO/FPO for each constituent PSU and give some semblance of portfolio stability to the investment. How much this appeals to local financial institutions is the key question. It is institutional demand that really gave the initial impetus to ETFs in the US. The other factor is the capacity and standing of the sponsor has always been key during ETF issuances since a strong, well spread out sponsor will bring it the much need liquidity without which ETFs generally fail.

 I will be exhorting whoever I can and whoever is bothered to listen to max up their contributions in RGESS. While direct investing in equity is always better when we are taking about holding it through a full business cycle, ETFs could be better for people who do not have enough financial savvy as it takes the guesswork out of the process. Here are some useful links to additional material on the topic:

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