Only a limited set of investors should invest directly in corporate bonds.
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Issuance of corporate bonds rated BBB+, BBB, and BBB-, the lowest tiers of investment grade before entering junk territory, has increased significantly in recent quarters, according to media reports.
With online bond platform providers (OBPPs) making bonds more accessible, many retail investors are venturing into these instruments.
They must conduct proper due diligence and avoid chasing yields blindly. Many well-known names like IL&FS, DHFL, Reliance Capital and SREI have defaulted in the past.
Higher returns
One key attraction of corporate bonds is higher returns.
“Most fixed deposits and small savings schemes typically deliver returns of around 7 to 8 per cent. Investment-grade corporate bonds can offer returns ranging from 7 to 14 per cent,” says Suresh Darak, founder, Bondbazaar.
Another benefit is liquidity. Small savings schemes and FDs have a lock-in period or penalty on early closure.
Bonds are tradable instruments, which investors can sell any time in the secondary market without paying a penalty.
OBPPs have broadened market access.
“Investors can now access a wide range of issuers starting with as little as Rs 10,000,” says Vishal Goenka, co-founder, IndiaBonds.com.
Understand the risks
Corporate bonds carry three main risks: Credit, interest rate, and liquidity.
Credit risk is the possibility of the issuer failing to make full and timely payment of principal and interest.
Then there is interest rate risk: An increase in interest rates within the economy results in prices of existing bonds declining, impacting investors who plan to sell a bond before maturity.
Liquidity risk arises because many bonds have thin trading volumes, making an exit without taking a price cut difficult.
How to manage credit risk
Check a bond’s credit rating and stick to higher-rated ones for safety.
“Bonds rated AA and above signal strong creditworthiness and typically offer 6.75 to 9.75 per cent yields.
“High-grade papers remain the preferred route for those focused on capital preservation and consistent returns,” says Goenka.
Darak suggests that first-time investors should start with highly rated corporate bonds (AAA and AA) and later venture into other investment-grade bonds (rated A or BBB).
New investors should also start with bonds of shorter duration of one to two years.
“Only after they have gained expertise should they explore longer tenures of four to five years or more,” says Darak.
The risk of a company’s financials deteriorating is lower over a short tenure.
Investors, especially those going for higher-yield ones, should limit their exposure to each bond.
“Diversification reduces risk while still offering high yields to the investor,” says Saurav Ghosh, co-founder, Jiraaf.
Managing other risks
Interest rate risk becomes irrelevant if bonds are held till maturity.
“Align duration with goals,” says Ghosh.
Investors who intend to exit early should choose liquid bonds with high trade volumes.
Investors should also ladder their investments — build a portfolio with bonds of different maturities — to deal with reinvestment risk.
“Staggered maturities offer ongoing liquidity and help avoid the risk of reinvesting a large lump sum when rates are low,” says Raghvendra Nath, managing director, Ladderup Asset Managers.
He also recommends checking if a bond can be recalled early, as this can affect the investor’s returns.
Run these additional checks
Credit ratings offer a quick assessment but are not foolproof.
“Investors should examine the issuer’s financials — debt-to-equity ratio, interest coverage (2.5x or higher is healthy), promoter credibility, sectoral performance, and past repayment record.
“Also, consider recent rating outlooks or downgrades.
“Sector exposure also matters — issuers in cyclical industries face more volatility,” says Goenka.
Avoid bonds which come with claims of high return and low risk.
“Such claims are often misleading, as higher returns typically come with a higher risk of volatility,” says Abhishek Kumar, Securities and Exchange Board of India (Sebi)-registered investment adviser and founder, SahajMoney.com.
Is direct bond investing for you?
Only a limited set of investors should invest directly in corporate bonds.
“It is for investors who diligently research the market and are comfortable doing credit risk analysis,” says Kumar.
Nath suggests that less experienced investors opt for debt mutual funds instead.
Begin with a moderate allocation to corporate bonds.
“Allocate 10-20 per cent to them within your fixed income portfolio, ensuring the rest is diversified among safer instruments like government bonds and fixed deposits,” says Kumar.
Factor in both rating and return
Note: Table includes AA and above-rated bonds currently available
Source: Jiraaf
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Feature Presentation: Ashish Narsale/Rediff