Check issuer's finances, debt repayment record before investing in bonds

Diversify across bonds with different credit ratings and hold them till maturity

The Securities and Exchange Board of India (Sebi) has decided to reduce the minimum face value of privately placed non-convertible debentures (NCDs) from ~1 lakh to ~10,000. The face value had earlier been lowered from ~10 lakh to ~1 lakh in October 2022. The bulk of all NCD offers take place through the private placement route. This is a landmark step that is expected to boost retail participation in the bond market.

With this measure, the regulator has lowered the entry barrier into the bond market. “Youngsters and those with lower amounts to invest will also be able to participate in it,” says Vijay Kuppa, chief executive officer (CEO), InCred Money. A lower ticket size, according to him, will also allow such investors to build a more diversified portfolio.

Sebi has also proposed to standardise the record date to 15 days before the due date for payment of interest or principal. This means investors must hold the bonds at least 15 days before this date to be eligible for payment. “Until now, every issuer followed its own methodology. Standardisation will make the market more efficient and less complex,” says Vishal Goenka, co-founder, IndiaBonds.com

According to Kuppa, Sebi’s stipulation that the issuer must appoint a merchant banker will ensure that retail investors’ safety is not compromised.

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Portfolio stability, regular cash flows

Bonds, which pay out coupons on fixed dates, are a good option for investors who want regular cash flows. They also offer the chance to earn stable but inflation-beating returns.

Interest rates are currently at peak levels. “By directly investing in bonds investors can lock in interest rates till maturity,” says Puneet Sharma, CEO and fund manager, Whitespace Alpha.

Interest rates are expected to decline both globally and in India, which could result in mark-to-market gains. “If an investor wants to book gains in the event of interest rates going down, secondary market sale of bonds should become easier and more efficient, given the lower face value,” adds Sharma.

Investors who only have equities and real estate in their portfolios should diversify into bonds for stability. “Such diversification is especially important now when equity valuations are elevated,” says Kuppa. The elections, too, could induce volatility. 

Beware credit, liquidity risk

Investors must watch out for credit risk. This refers to the possibility that the bond issuer may not honour the principal or coupon payments on the scheduled dates, eroding investors’ capital. “Credit risk is strongly correlated with the economic cycle. When growth is strong, credit risk tends to be lower. But when there is a slowdown, defaults go up,” says Kuppa.

The second risk is liquidity risk. The secondary bond market can be quite illiquid, especially for lower-rated bonds (AAA-rated bonds enjoy higher liquidity). “If investors want to exit a bond midway through its tenure, they may have to wait for some time to find a buyer at the right price, or take a haircut,” says Ankit Gupta, founder, BondsIndia.

The third is interest-rate risk. It comes to the fore in a rising interest-rate scenario. Longer-duration bonds are affected more by it. Currently, with interest rates at or near the peak and poised to go down over the next 12 months, investors need not worry too much about this risk.

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Runs these checks before investing

Avoid selecting a bond merely based on its coupon and yield. Examine the quality of the issuer. Do some research on its track record of repaying debt. Goenka suggests checking the financials to get a sense of its projected cash flows.

Next, check whether the bond is secured or unsecured. A secured bond is backed by collateral. In case of a default, the collateral can be sold to pay back the lenders. This provides an additional layer of safety.

Investors who cannot run these checks should take a financial advisor’s help. Online bond platforms also claim to do due diligence and offer their customers a curated list.

Build diversified portfolio

Check a bond’s ratings and try to build a diversified portfolio. “Just because some bonds are offering double-digit returns does not mean you should park your entire bond portfolio in them. Instead, diversify across bonds having different ratings,” says Kuppa. According to Goenka, not more than 20-25 per cent of an investor’s bond portfolio should be in high-yield bonds.

Goenka suggests that investors should match a bond’s tenure with their investment horizon. By holding a bond till maturity, they can eliminate both liquidity and interest-rate risk.

Study the bond’s amortisation schedule. While in many bonds the principal is returned at the end of the tenure, in the case of some the borrower returns part of the principal at regular intervals. “Not only does the bond holder get back a portion of what he has lent, such repayments also demonstrate the borrower’s confidence about meeting its obligations,” says Kuppa.

If you invest in a higher-yielding bond (having a lower credit rating), avoid a tenure of more than three years. “Over a longer period, the risk that the company’s financials may deteriorate and it may default goes up,” says Gupta.

Avoid investing either in a bond that is not rated or one not listed on the exchanges. “If you invest in an unlisted bond and something goes wrong, you will not be able to approach the regulator for redress,” says Gupta. He also urges investors to stick to secured bonds from well-known promoters.

Finally, Goenka suggests sticking to Sebi-regulated online bond platforms for bond purchases and avoiding complex structured bonds.