The last quarter was more than eventful for the fixed-income market. Its cup of unsettling news was overflowing.

A number of corporate borrowers had to meet large commitments, whispers of default were heard, and credit rating agencies stood on high alert. Concerned quarters had questions — were certain companies about to backtrack on deadlines, were missed payments around the corner? All told, fixed-income investors had their share of unsettling thoughts to grapple with.

The situation once again triggered a series of queries, now playing on our minds. Are all manners of debt investments safe and sound in this day and age? What sort of fixed-income securities should merit our attention? What risks do our allocations face at this juncture? The beginning of a new financial year is the right juncture to consider these matters.

As serious debt investors will no doubt know, there are two constant concerns. Credit risks and interest rate risks are both critical for the market. One, the fear of being caught on the wrong foot, while interest rates change in keeping with regulatory policies, is always palpable. Two, the probability of default, following non-payment of interest or principal, is a relentless worry. For the sake of today’s discussion, we will limit ourselves to the second concern.

As it happens, the last few months have not been quite placid for investors. The Reserve Bank of India, having announced a cut in the repo rate in February, will unveil the next credit policy in early April.

The market is bracing for another snip, perhaps now or a few months down the line. With the prospect of rate-cut looming large, and the domain of corporate debt hit by negative news off and on, investors are generally being cautious with their fixed-income allocations.

While we will not refer to specific cases here, a few points are worth noting if we wish to look forward. We have listed them for you.

• Policy modifications are expected to be announced in the days ahead. Our retail investors need to keep an eye on headline inflation numbers to see whether their loans will be repriced. Home loans, which play a crucial role in the economy, will be their focal point. Ditto for interest rates on bank fixed deposits.
• Credit rating agencies will be closely watched too. Big rating actions will attract eyeballs, especially if such moves have a bearing on well-known corporate entities. Raters will continue to play a major role in the months to come.
• Investors, including retail participants, will want to take tactical calls with regard to their fixed-income allocations. We expect a significant number of them to engage exclusively in short-term debt. Longer debt, many feel, should be avoided for the time being.
• Debt funds will not pare their strategy for now. Investors, who look up to asset management companies for stability and income generation, know that there is a range of compelling categories of funds. They need to consult their advisers and other professionals when it comes to the question of choosing the right names.

What now?

Let us, purely as a conjecture, assume there will be more than moderate credit risk in certain pockets of the market.

When credit risk steps up, expectations with regard to returns may also escalate in some quarters. Keeping this in mind, a debt portfolio’s overall credit profile must be scrutinised properly — especially if the portfolio in question claims to deliver high (read: more than normal) returns. Investors must also note that credit ratings can mutate quickly, even overnight, if the circumstances change dramatically.

Portfolio managers must, therefore, track all rating actions relevant to their holdings. Is there a probable rating downgrade? That question must be answered at the earliest, particularly because valuations will depend on it.

For the record, a downgrading has an immediate impact on portfolio quality. And the opposite is also true, which means a credit upgrade will have its benefits as well.

Investors must not lose sight of the fact that interest rates and debt valuations have an inverse relationship. The See-saw Effect. In other words, when interest rates change, the market prices of debt securities (such as bonds) will also get modified. This has been observed time and again; the reasons are very precise and easy to comprehend. It also draws investors’ attention to the concept of modified duration. This gauges a bond’s price sensitivity in the context of interest rate changes.

As we all know, the banking regulator is well on its way to tackle inflation as part of its overall policy. Inflation and other macro forces will all play their parts in the times ahead.

Prices, incidentally, have been tamed somewhat — a trend that is evident from recent numbers. We expect debt portfolios to maintain robust management practices in order to meet their investment mandates.

A number of to-do’s for investors spring to mind in this context. The most important of these relates to diversification. Participants, we hope, will allocate to a range of debt securities, and not limit themselves to just a handful. The end-result must be sufficiently broad-based — there should be enough diversification in terms of issuers, paper quality, maturity profile and the like.

The average investor must understand his own investment horizon. Or else he will end up making a cardinal mistake — investing short-term money in long-term paper, and long-term money in short-term paper. Such a bloomer will most certainly hurt his ability to generate decent returns.