Understand the nuances of retail direct bond before investing: Experts

Be aware that it carries credit, interest-rate, and liquidity risks and makes diversification difficult

Several new platforms have been launched in recent months that allow retail investors to invest directly in bonds like Bondskart.com from JM Financial, BondsIndia.com, and the Reserve Bank of India’s Retail Direct Scheme.

However, as Juzer Gabajiwala, director, Ventura Securities, says: “While the opportunity has become available, retail investors need to ask themselves whether they understand the nuances of direct bond investing.”

Customise by going direct

Investors keen on building customised bond portfolios may want to invest directly. Some may, for instance, want to allocate some money to instruments like market-linked debentures. Others may want to venture into lower-rated bonds (‘A’ and ‘BBB’) for higher returns. These are areas that debt mutual funds usually shy away from. Says Puneet Aggarwal, co-founder, BondsIndia.com: “If you invest directly, you know where you are investing. If you choose the mutual fund route, the fund manager decides where to invest.”

Weigh the charges

Direct bond platforms score over debt mutual funds on charges. “No charges or fees are levied from the investor when he takes the direct route via our platform,” says Aggarwal. Investing via the RBI’s Retail Direct Scheme also entails no cost. Debt MFs, on the other hand, levy an annual expense ratio.

Professional management

Debt MFs, though, have a number of advantages. Investing in bonds requires a good understanding of the macro situation, like the economic environment (more defaults and downgrades happen when the economy is faring poorly), interest rate outlook (bond prices have an inverse correlation with interest rates), and so on. Investors also need to be able to assess each issuer’s credit risk.

The majority of retail investors lack both the knowledge and the time to evaluate individual bonds properly. They may also not be able to monitor them regularly after purchase.

MFs have professional managers and a team that analyses, selects, and monitors each security. “By taking the direct route, you will miss out on the expertise of professional fund managers,” says Joydeep Sen, corporate trainer (debt) and author.

Diversified holding

Many bonds can have a face value of, say, ~1 lakh or higher (the bond’s actual price will be at a premium or discount to the face value). Government bonds have a face value of ~10,000. Retail investors, with their limited corpus, may at times find it difficult to build a diversified portfolio by investing directly. Debt MFs, on the other hand, give investors access to a diversified portfolio for sometimes as little as ~1,000.

A diversified portfolio reduces issuer-specific risk. “Debt MFs offer retail investors access to both debt and money market instruments. They often combine government and corporate bonds in their portfolios,” says Gabajiwala.

Liquidity issues

In many cases, bonds trade only in large lots. Individual investors with a lakh or two worth of bonds may find no takers. Lower-rated bonds (like ‘AA’ and ‘A’) tend to be especially illiquid in the secondary market. Liquidity dries up further in adverse market conditions.

Investors keen on interim liquidity will be better off taking the debt MF route. “Once you have put in a redemption request in MFs, it is the fund’s job to generate liquidity. In direct bonds, liquidity may be available in highly-rated bonds but is a question mark in lower-rated ones. If you try to sell a bond during its tenure, you may have to accept adverse pricing,” says Sen.

What should you do?

Investors keen on locking in rates for the very long term may take the Retail Direct Scheme route. Also, by sticking to higher credit quality bonds and holding them till maturity, retail investors can circumvent both credit and interest-rate risk.

Finally, only those who understand the debt market’s nuances and have deep pockets should opt for direct bond investing. Most others will be better off letting professional fund managers handle their investments.