Corporate bonds help in spreading risks and improving returns
Corporate bonds are an attractive investment avenue for retail investors . They offer higher returns and can be traded for capital gains. Some infrastructure companies’ bonds offer tax deduction under Section 80CCF. Many blue chip companies have either come or are likely to come in the market for issuing bonds.
Companies and financial institutions raise funds needed for growth and expansion through bonds. In return, investors are paid interest and get back the principal amount on maturity. In the past, several companies such as Tata Capital, L&T Finance and Shriram Transport offered non-convertible debentures (NCDs). IFCI came out with an infrastructure bond in August. And now IDFC is offering infrastructure bonds too. All this has led to a growing interest in bonds. But there are some risks involved and one must know how to trade if the product suits his investment portfolio.
Bonds
Corporate bonds are usually issued with a face value of Rs 1,000, Rs 5,000, Rs 10,000 or Rs 1,00,000. They can be of short-term, medium-term or long-term maturities. They are usually in the nature of a promissory note or either secured or unsecured NCDs. They either carry a fixed or floating rate coupon. In India, most companies offer fixed interest rate-bearing bonds. They are usually issued in dematerialised format. They can either be cumulative or non-cumulative. Some companies have a put or call option in case the bonds are of longer duration; for instance, the current IDFC issue has a buyback facility. Zero-coupon bonds (ZCBs) are also available, issued at discount to the face value.
Some bonds are listed on stock exchanges and you could make a profit by selling your corporate bonds in the open market before maturity. Interest rates and prices have an inverse relationship. So, a good time to buy the bonds is when the interest rates are high. When interest rates fall, you may sell them at a pemium.
Risks
At times, the company issuing the bonds may not be able to service these or repay the principal amount if it is facing a cash crunch. This will mean you cannot get your principal amount or the interest. Also a particular bond may not have much liquidity or value in the open market. One way to avoid this is to properly check the financial credentials and rating of the company you want to invest in. You can do this by looking at its financial position, cash flow and debt-equity ratio. Also, check the rating given by agencies such as Crisil, Icra and Fitch. These agencies rate the credit quality of companies floating bonds. The higher the rating, the better the chances of getting timely interest on your bonds, besides full repayment of principal on maturity.
Other risks include the increase in interest rates. If you are forced to sell your bonds at such a time, before they have matured, then you could lose out due to depreciation in investment (on account of upward movement in interest rates).
Another deterrent is the fact that bonds offer pre-determined interest rates. These may offer a lower rate as compared to other investment options which have higher liquidity and flexibility in interest rates; hence, they may not offer much protection against inflation. There is a reinvestment risk, too, in case you take the non-cumulative option.
Tax aspect
The interest earned on the bonds is taxable as income and usually liable for tax deduction at source (TDS). Any gain on account of trading in bonds will be treated as short-term or long-term capital gains, depending on the tenure of investment, and taxed accordingly.
The government has given an additional tax benefit to infrastructure bonds under Section 80CCF. A member of a Hindu undivided family (HUF) or an individual can invest up to Rs 20,000 in infrastructure bonds issued by certain institutions, as notified by the Reserve Bank of India. The current IDFC bond is one such issue which will enable you to get tax benefit. This will be over the Rs 1 lakh deduction allowed under Section 80C. An investor who is in the highest tax bracket of 30 per cent can save an additional Rs 6,180 and those in the lower tax bracket can save Rs 2,060 by investing in infrastructure bonds this financial year. These bonds also offer the stability of fixed returns and ensure relative safety of capital.
The tax treatment for zero-coupon bonds is slightly different. The differential income arising on sale or redemption of these bonds is treated as short-term or long-term capital gain, depending on the period of holding. In case the realised gain is long-term capital gain, the tax liability will be 10 per cent, plus applicable surcharge and cess without indexation benefit or 20 per cent with indexation benefit, whichever is lower. There is no TDS deduction in case of zero-coupon bonds like the Nabard Bhavishya Nirman Bonds, for instance.
Limitations
Most bonds have low liquidity. Although they may be listed on the stock exchange, they are not frequently traded. This means there is no guarantee of you being able to sell or redeem these in time of need. Another aspect is that they are issued in dematerialised form, so having a demat account is mandatory.
Bonds are available in a range of credit quality characteristics, to suit different risk-return preferences. Although slightly more risky than bank fixed deposits or post office savings, they can offer much better rewards and, at times, capital gains, too. If you want to diversify your investment portfolio and ensure steady interest return for a longer tenure, then corporate bonds are the ideal choice.
The author is an investment analyst and freelance writer
