The need for ready cash in hand is felt by all in different circumstances, be it for day-to-day expenses or an emergency situation. Keeping some money in hand or in assets that can be liquidated easily to generate cash is a key part of prudent management of personal finances.
Asset classes have different levels of liquidity and there are instruments within a particular asset class that may be more or less liquid than others. These instruments do carry different levels of risk too.
For example, investment in real estate is generally considered illiquid since it takes time and regulatory compliances to sell a property and receive the cash. There could also be sizable transaction costs involved and the possibility of a distress discount, if the money is required immediately. On the other hand, while equities and gold are generally considered highly liquid, they are perceived as risky as their prices are volatile and are subject to macroeconomic, socio-political and other shocks. Debt as an asset class is generally less liquid than equities though there are some debt instruments that are easier to liquidate than others. Debt as an asset class also has lower risk associated than equities.
Varying shades within debt
Many investors with risk-taking capacity aim at building a stable portfolio of fixed income products. As these instruments are associated with low volatility and steady returns, these investors find comfort in putting their money in debt investments. However, many times such fixed income portfolios suffer from low liquidity. For example, small savings schemes administered by the government and fixed income investment options such as Public Provident Fund (PPF), National Savings Certificate (NSC) and Senior Citizens Savings Scheme (SCSS), score low on intermittent liquidity, though they carry little credit risk.
While G-Secs and AAA rated bonds score high on this front, bonds with ratings below AA may not always trade near fair value markets.
However, a prudent bond investor can take a few steps to ensure that there is ample liquidity in his fixed income portfolio.
Balance yield with quality
In search of high yield, many investors load up on bonds with credit rating below AA. As investors go down the credit ratings ladder, liquidity in the secondary market dries up too, while the yields go up. Generally, the lower the rating, the higher would be the coupon rate offered on the instrument. Such high-yield bonds should generally be bought with the intention to hold till maturity. In such a scenario, it is better to allocate some money to AAA-rated listed bonds. In India, bonds issued by public sector undertakings (PSUs) are also much sought after investments. Generally, these high-quality bonds are always in demand and trade near fair value. Even in times of market dislocation, an investor can quickly sell them and raise cash.
A prudent investor can consider allocating minimum 20-25 percent of his/her fixed income allocation to high-quality and higher rated bonds. Corporate bonds with AAA rating offer good yields and can be included in the portfolio to improve liquidity without sacrificing much on the returns.
Gain liquidity from laddering
While AAA-rated bonds of good quality offer liquidity to the portfolio, investors cannot ignore high-yield bonds to improve their overall returns. A more calculated way of investing in these bonds can be through laddering.
Laddering involves buying bonds maturing across time periods. For example, buy bonds that mature one, two, three, five, seven and ten years from now. This ensures that investors keep getting some cash flow at regular intervals. Such maturity proceeds can be used along with interest receipts if there is an income need or can be reinvested in appropriate investments at that point of time, keeping future possible requirements in mind.
Investors looking to buy bonds online should first ascertain their liquidity needs. If an investor has a financial goal or a cash flow requirement at the end of three years, then she should ideally be investing in a bond which matures in less than three years. This approach involving holding bonds till maturity ensures that the investor does not confront a situation wherein he/she has to sell the bonds at stressed valuations.
Invest in debt mutual funds
While the above two moves can offer a significant amount of comfort to investors, a more conservative investor who wants assured liquidity can invest in debt schemes of mutual funds. These schemes provide investors an opportunity to liquidate their holdings at net asset value (NAV) and pay out the sale proceeds within one to two days of placing the redemption order depending on the nature of the scheme.
In the last couple of years, the capital market regulator has taken many steps to ensure that rights of investors in debt funds are protected, especially in times of market dislocation. This includes the more recent move by SEBI to institute a corporate debt market development fund (CDMDF). The fund, when constituted, would work as backstop arrangement for debt funds and would enable them to secure lines of credit in time of stress in the debt market, thereby ensuring liquidity.
An investor can consider allocating between 10-15 percent of portfolio to debt funds.
However, while
picking a debt scheme, the expense ratio of the scheme must be checked. High
expense ratio eats into the scheme’s returns. Prudent investors should also
check the performance track record of the funds and current portfolios of the scheme.
This helps in setting the expectations right since the debt funds offer market
linked returns and do not guarantee performance.
Team Altifi