There are several markets across the broader emerging market (EM) world that offer yield – India is no different in that sense – but very few match Indian bonds for their high yield 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) which is facing teething issues – 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 EM 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.
Aside from the fact 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 to obtain one requires a lot of legwork. This tends to mean institutional investors in the region are more structural and those that are present don’t sell at the whim of an awry non-farm payrolls number or a data point that wasn’t quite in line with expectations. A greater percentage of foreign flows has also been 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.
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.