Missed out on tax-free bonds? Try perpetual bonds

Yield differential of perpetual bonds vis a vis 10-year benchmark govt securities are at high levels of 250-300 basis points

With interest rates falling, high networth have the option of an interesting debt instrument, namely, perpetual bonds. And according to wealth managers, many are actively looking at this instrument.

These bonds are issued by banks and companies to raise long-term funds. Currently, the yield differential of perpetual bonds vis a vis the 10-year benchmark government securities are at high levels of 250-300 basis points.

"But yields are expected to shrink in the medium term, within two years," says Anshu Kapoor, head, Edelweiss Global Wealth Management.

Typically, insurance companies and institutions invest in perpetual bonds. Since these are privately placed, bond lead managers subscribe to them in bulk and sell them to individual investors in smaller lots.

Usually, the bonds are issued with face value of Rs 10 lakh. An investor can buy an individual bond and in multiples of one bond thereafter in the secondary market, says Kapoor. Perpetual bonds are listed on wholesale debt market platform (WDM platform) and are traded over the counter.

However, liquidity is an issue. The only way to exit is through the call option provided by the issuer, which could be five or 10 years after the issue, or by selling them in the secondary market.



Since these bonds are perpetual, there is no maturity. But the 'put' and 'call' option will allow an exit route. A call option is when the issuer calls back the bond at a fixed date, usually before maturity. Similarly, a put option is when investors have the option to redeem the bond back to the issuer at a fixed date.

"While investing in perpetual bonds investors should look at the liquidity because redeeming these bonds is the only way to gain from interest rate decline. Investors should also look at the yield-to -call or yield-to-put. If the call option is after 10 years, the yields will be similar to a 10-year debenture of the same company," says Feroze Azeez, deputy CEO, Anand Rathi Private Wealth Management.

So how do they compare with tax-free bonds? While perpetual bonds offer higher coupon rates than tax-free bonds, liquidity can be issue, says Azeez. HNIs who do not get allotment in tax-free bonds can look at perpetual bonds as an alternative since they offer similar features, that is, assured interest income. And allotment may be easier in case of perpetual bonds, as compared to tax-free bonds.

As far as returns go, the yield-to-call (the yield investors will get if the bond is held till the call date) on Tata Steel's perpetual bond is 9.97%. The call date is when the bond will be repurchased by the issuer. In comparison, Power Finance Corporation offered 7.36% to 7.6% for maturities of 10-20 years. The returns are tax free in the latter case.

While tax-free bonds offer a tax advantage on the coupon, a perpetual bond, though not tax efficient offers a higher coupon, when compared to other bonds having a similar rating. But perpetual bonds carry relatively higher risk as compared to a tax-free bond, points out Kapoor.

Raghavendra Nath, Managing Director - Ladderup Wealth Management says that perpetual bonds can be used to diversify your portfolio. "For someone in the highest tax bracket tax-free bonds are a better option.

But those who are close to retirement can put some money in perpetual bonds. You can purchase them through debt brokers,'' he says. Perpetual bonds are subject to long-term and short-term capital gains similar to other debt instruments.