Trying out bonds as an investment option

Vijay C Roy

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“It’s only when the tide goes out that you learn who has been swimming naked.” Warren Buffett’s remarks confront the market psychology and herd mentality. The popular quote holds true today too.

India’s investment market has seen a sharp rise with a huge number of retail investors beginning to populate their portfolios in the past five years. However, not all financial instruments are the same. One that works for an individual may be a bit too risky for another. Traditionally, investing in bonds has been considered low risk for long-term bets. With awareness levels picking up, these are becoming a go-to investment option.

KEY TERMINOLOGIES

Value

Also known as ‘Par Value’, it represents fundamental value of the bond. In India, the most frequent face value is Rs 1,000.

Coupon Rate

The rate of interest paid by the bond issuer to investors. A bond with a coupon rate of 10 per cent means that the bond will pay interest @10 per cent per annum on the face value of the bond.

Maturity

The predetermined date at which the issuer repays the principal amount. For instance, if the maturity period is five years, then the bond issuer will repay the principal after five years.

Current Price

Bonds are frequently traded in the open market, where the current price refers to the quoted price. If the bond is trading at Rs 4,000 in the exchange, then Rs 4,000 will be the current price.

Yield

It’s the return you, as an investor, receive for holding the bond. For example,

suppose you earn an interest of Rs 200 and the bond is priced at Rs 1,500, the yield of this bond will be 13.33% (i.e. Rs 200/Rs 1,500 * 100).

What are bonds

Bonds are simply loans. When investing in bonds, the investor is essentially lending money to the issuing authority or the company. Bonds are a form of debt-financing that allows entities to raise capital by borrowing money from investors. A unique aspect of bonds is their fixed-income nature, which means that investors receive a regular stream of interest payments at a predetermined rate.

In India, bonds are issued by the Reserve Bank of India (RBI), Central and state governments, PSUs, and corporations. National and state governments issue government bonds to finance public expenditure. Local authorities issue municipal bonds to fund projects.

Also, companies issue corporate bonds to raise money for various purposes, such as expansion or working capital.

Different Types of Bonds

1. Fixed rate bonds: Fixed-rate bonds are the ones that keep paying interest at a predetermined rate until the bond matures.
2. Floating rate bonds: The returns on floating-rate bonds are variable.
3. Zero coupon bonds: There are no coupon or interest payments made in these bonds from the time they are issued. Investors purchase the bonds at a discounted rate and get repaid a lumpsum par value at maturity.
4. Perpetual bonds: These do not have a fixed maturity date, so theoretically the issuer does not have to repay the principal ever. These bonds pay interest payments regularly.
5. Inflation-linked bonds: These are fixed-income securities whose principal and coupon are linked to inflation through a price index. These are designed to hedge against long-term inflation risk to the bondholders.
6. Convertible bonds: You can convert these into shares of holding company.
7. Callable bonds: Can be redeemed before maturity and the issuer of the callable bonds may pay the dues to the investor and redeem the bonds at a predetermined time.
8. Puttable bonds: Investors have the right to return the bond to the issuer before the maturity date. The issuer shall make the payment towards the principal at a predetermined rate.

Normally, bond yields vary from 7 to 12 per cent per annum. “Most investors put their money in bonds to diversify their portfolio and earn a regular passive income. These are one of the most popular investment avenues for risk-averse investors,” says Vishal Goenka, co-founder, IndiaBonds.com, an online bond platform provider.

A bond can start at as low as Rs 1,000. Listed bonds are regulated by the SEBI, which acts as a watchdog for listed securities to prevent any irregularity and protect the investors’ interests.

Bonds can be judged in terms of yield, maturity, payment frequency, investment goal, and risk appetite. For example, sovereign gold bond is a popular option as it provides the benefits of gold appreciation, long-term tax saving and regular income. However, before investing, one should undertake fundamental research about the company.

Primary and secondary markets

The Indian debt market is fairly large, with the bond market sized at around $2.34 trillion. Of this, $1.83 trillion is dedicated to government bonds, while $510 billion is allocated to corporate bonds (as of March 22, source: CCIL, SEBI). Government bonds constitute 78 per cent of the overall outstanding bonds in the country, while corporate bonds account for 22 per cent of the market.

where to buy

One can start investing in bonds through:

Online bond investment platforms

Registered brokers qualified to trade on investors’ behalf.

Directly through an exchange

RBI’s Retail Direct Scheme, NSE & BSE apps.

The primary market is fundamentally the place where companies raise capital through the initial issuance of securities (such as stocks or debentures) to investors. The secondary market refers to the trading of previously issued securities. As with all financial investments, even bonds come with associated risks. Only government securities are deemed to be risk-free as they are guaranteed by the Central government. For corporate bond investments, investors must do their due diligence.

Bonds vs Equities or Stocks

Bonds are considered relatively less risky as bondholders have priority in receiving payment and interest payments are fixed. Equities pose a much higher risk, given their susceptibility to volatile fluctuations. In case of bonds, the returns are more predictable, stable and reliable. In case of bankruptcy, bondholders are given priority because they are creditors who have loaned money.

Bonds vs Fixed Deposits

In 2017, a SEBI survey revealed that over 95 per cent of households preferred FDs as their investment option, with only 10 per cent opting for mutual funds and stocks. Bond investing is still not popular for two primary reasons: a heavy reliance on FDs and a lack of awareness regarding them. Bonds generally offer a higher return than fixed deposits, especially for those with longer maturity periods and the possibility of capital gains. Also, bonds can be bought and sold on the market. Fixed deposits are less liquid as they are typically held until maturity. However, some banks may offer the option to withdraw the funds early with a penalty.

Things to keep in mind while Investing

• Read the offer documents carefully.
• While investing in bonds, keep a few parameters in mind like the rating of a bond, residual tenure, security structure, seniority of the bond, etc. This will help you to compare bonds and make an informed decision.
• Credit ratings of each bond will assist in understanding risks where AAA is safest and BBB carries much higher risk and is suitable for institutional investors.

Bonds vs PPF

While both bonds and the Public Provident Fund scheme are fixed-income instruments, they are quite different. Some corporate bonds might also offer higher returns. Also, investment in bonds depends on the value of the bond and starts from a minimum of Rs 1,000. In PPF, the minimum investment is Rs 500 and maximum is Rs 1.5 lakh in a year.

Tax benefits

Bonds are mostly taxable with a 10 per cent TDS of coupon deduction. There are a handful of tax-free bonds as well. In case of PPF, the invested amount is tax-free under Section 80C. Interest earned and the maturity amount is also fully tax-free.

Factors affecting the prices

Bond prices are impacted by market interest rates. “Whenever the rates fall, bond prices go up. Conversely, if the market rates go up, the bond prices plummet. Also, bond prices go down when inflation shows an incremental trend,” says Goenka. Also, a good credit score shows financial stability of the bond issuer. If the credit ratings go down, the prices of bonds issued by that organisation also fall.