Corp bond spreads shrink on change in investor appetite

Investors have begun to choose top-rated corporate bonds over government securities, as there is no clarity on the course of yields on the latter. As a result, yields on corporate bonds have not moved in line with those on government securities over the past three months. Instead, the spreads over government securities have narrowed.

The increase in demand for longer dated papers as against limited number of issuances has led to softening in yields on corporate bonds. “There is a good demand from insurance companies and provident fund managers for top-rated corporate bonds. Subject to our investment limits, we look at ‘AAA’ corporate bonds, as they offer favourable spreads over government security,” said S P Prabhu, vice-president (fixed income), IDBI Federal Life Insurance.

 

Yields on 10-year ‘AAA’ corporate bonds stand at 9.40-9.50 per cent at present, down from 9.60-9.70 per cent since June, whereas yields on 10-year government security have been around 8.3 per cent levels in the same period. The spreads between 10-year corporate bonds and government security of the same tenure has narrowed from 125 basis points in June to 85 basis points in September.

“There is a bit of uncertainty in the interest rate scenario. Issuers, as well as investors, are not very sure where interest rates are headed and there has been a continuous supply of government bonds every week,” said a dealer with a Mumbai-based brokerage. He added that traders were also pricing in the possibility of more than planned government borrowing this year. “So, our preferred form of investment other than government securities is going to be AAAs,” he said.

Investors are anticipating interest rates to moderate in the medium term and are looking at opportunities to lock in their funds at the current rates. “Investor preference has turned to longer-duration debt issuances, since the interest rates at the shorter end have come off double digits over a few months,” said Ajay Manglunia, senior vice-president, Edelweiss Securities. At present, certificates of deposit and commercial papers are being issued at around 9.4 per cent for one-year duration.

Also, the banks holding government securities in excess of 24 per cent, the minimum requirement for Statutory Liquidity Ratio (SLR), are open to investing in corporate papers. “We are investing in corporate bonds currently as they are good for yield pick-up in the portfolio,” said a treasury official of a large public sector bank. With the repo rate at eight per cent, it made more sense to deploy funds in higher-yielding corporate bonds and make good for increase in cost of funds, he added.