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India: the story isn’t just about yield

India: the story isn’t just about yield

  • 02Oct 17
  • Kenneth Akintewe Senior Investment Manager, Aberdeen Standard Investments

There are several markets across the broader emerging-market world that offer yield, and India is no different in that sense. However, very few match Indian bonds for their high yields and low-volatility characteristics.

India is increasingly on investors’ radars. It’s not difficult to see why: the nation boasts the fastest-growing economy globally, and Prime Minister Narendra Modi continues to push through with his ambitious reform agenda. While there’s been some negative press in recent weeks around the success of some of these reforms – notably the Goods & Services Tax (GST) – it’s important to remember that these are long term positives. Patience is required before the benefits begin to filter through to the economy.

In terms of the bond market, there has been significant progress made over the last decade. The market is now both large and liquid – two key components of any successful bond market. India’s local-currency bonds also have very low correlations to other asset classes; they are less influenced by wider global sentiment. Instead, the economy is idiosyncratically and domestically driven by factors that can be forecasted more easily. Dealing costs also tend to be lower than many other emerging-market trades, and the average credit quality is investment grade.

But the real story behind India’s bonds is the high yield and low volatility. The two tend not go together, but India’s different. So what’s the catch?

Volatility of Indian local bonds has been low and stable

Source: Bloomberg, 30 June 2017. Market Volatility (rolling 6 month) vs. Macro Risk Index (MRI Citi Index). Past performance is not a guide to future results. GBI-EM GD is the JP Morgan GBI-EM Global Diversified Index (government bonds in local currencies); EMBI GD is the JP Morgan EMBI Global Diversified Index (government bonds in hard currencies); WGBI is the World Government Bond Index (fixed-rate, local currency, investment grade sovereign bonds).

Aside from the fact that access to the market is restricted and requires specialist experience, there is no catch. The Reserve Bank of India is doing a reputable job of managing inflation, Modi continues to deliver and India’s story is as compelling as ever despite a strong rupee and some slightly weaker-than-expected data. The impact from reform implementation is expected to be temporary and growth is forecast to gain steam going forward.

The restricted access to the market may seem strange, but it’s a big contributor to the low levels of volatility. A license is required before investing in local-currency bonds, and obtaining one requires a lot of legwork. This tends to mean institutional investors in the region are more structural and don’t sell at the whim of a non-farm payrolls number gone awry or a data point that wasn’t quite in line with expectations. A greater percentage of foreign flows has also come from other central banks and sovereign wealth funds, which is another reason for the low volatility levels. In short, India has kept the “lazy tourist” money out.

Exposure to the market is a prized possession these days, and those that have it will not give it up easily.

Given the potential of India’s reform story, a positive outlook and attractive market attributes, it would be a prime candidate for suffering from a build-up of consensus and crowded positioning if it were an open market. But thankfully, exposure to the market is still a prized possession and those that have it will not give it up easily.

Important Information

Fixed income securities are subject to certain risks including, but not limited to: interest rate (changes in interest rates may cause a decline in the market value of an investment), credit (changes in the financial condition of the issuer, borrower, counterparty, or underlying collateral), prepayment (debt issuers may repay or refinance their loans or obligations earlier than anticipated), call (some bonds allow the issuer to call a bond for redemption before it matures), and extension (principal repayments may not occur as quickly as anticipated, causing the expected maturity of a security to increase).

Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards, and political and economic risks. These risks are enhanced in emerging markets countries.

Indexes are unmanaged and are included for illustrative purposes only. You cannot invest directly in an index.

ID: US-150917-45988-1