Should you Boost your FD Portfolio with Corporate Bonds? A lesser known fixed income option but that can boost your fixed income portfolio is corporate bonds. Many good quality corporate bonds currently fetch 9-11% per annum yield compared to a 6-7% annual interest rate on 1-3 year bank FDs.
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According to experts, as it is important to diversify your equity portfolio, it is equally important to spread your fixed income investments. A lesser known fixed income option but that can boost your fixed income portfolio is corporate bonds. Many good quality corporate bonds currently fetch 9-11% per annum yield compared to a 6-7% annual interest rate on 1-3 year bank FDs. Take for instance the bonds, which are currently open for subscription- Credit Access Grameen Limited and Viviriti Capital. They hold a coupon of 9.10% to 9.57%, respectively. "Every asset class has a role to play in a portfolio: equity is for growth, and fixed-income instruments like corporate bonds offer stability in a portfolio and generate income," says Bhuvanesh R, AVP, Business Analysis, Zerodha & Rainmatter.
WHAT ARE CORPORATE BONDS
Corporate bonds are issued by companies for raising finance for a variety of reasons such as for building a new plant, buying equipment or for business expansion. They are typically issued for more than a year. So far this year, companies have raised INR 6240.49 crore by issuing bonds. "The maturity of corporate bonds can start as low as 24 months to 10 years – so this flexibility (maturity profiles) allows investors to align their investments with their specific financial objectives. Whether it's a short-term liquidity requirement or a long-term goal, corporate bonds can offer maturities that cater to diverse needs." says Gaurav Sharma, Vice-President, IND Money.
Over the years, the corporate bond market in India has grown. The outstanding stock of corporate bonds has increased four-fold from INR 10.51 lakh crore as at end of FY 2012 to INR 40.20 lakh crore as at end of FY 2022, according to RBI's bulletin Corporate Bond Markets in India - Challenges and Prospects dated Sept 16. 2022. Annual issuances during this period have increased from INR 3.80 lakh crore to close to INR 6.0 lakh crore. By 2025, according to Crisil, the outstanding corporate bond market in India is expected to double and reach INR 65-70 lakh crore.
REGULAR INTEREST PAYOUT
Corporate bonds have a defined term, known as the maturity date. Until the maturity date, bondholders typically receive periodic interest payments that can be made annually, semi-annually, or in other periodic intervals, depending on the terms of the bond. "As there is coupon payout, so you buy them with regular income perspective. Also, these bonds come with a lock-in - usually 3 yrs, 5 years to 10 years. So the idea is you hold the bond till maturity in your demat account and enjoy the regular income and exit at the maturity," adds Sharma.
The bond market in India can broadly be divided into two categories – one is privately placed listed bonds and the second is publicly issued listed bonds. For publicly issued bonds, the ticket size starts from INR 1,000 while for privately issued listed bonds, the ticket size starts from INR 1 lakh.
HOW TO INVEST
Investors can access corporate bonds through primary and secondary markets, as well mutual funds. In the primary market, bonds are purchased from the issuing company or underwriter during the IPO or bond issuance process. In the secondary market, existing bonds are bought and sold through brokers or bond exchanges, providing liquidity. There are many fixed income platforms such as Bondskart, BondsIndia, Axis Direct YIELD and Wint Wealth which help invest in corporate bonds. Another alternative for DIY retail investors looking to invest in corporate bonds is to invest in a corporate bond fund or through Bonds ETFs.
Higher returns on bonds are not without risks. The corporate bonds bear both credit and interest risk. Credit risk means the bond issuer may default on one or more payments before maturity. Thus, investors may lose some or all of the interest income and the principal amount invested. Interest risk comes in when interest rates rise above the rate locked in at the time of bond purchase. In this case, the bond's price falls, and the investors lose their principal capital if they sell before maturity. However, interest risk is irrelevant for someone holding the bond till maturity.
CHECKING FOR A CREDIT RATING
Don't make the mistake of thinking of a corporate bond like a Bank FD which is secured by the Deposit Insurance and Credit Guarantee Corporation (DICGC). As they carry some risk it is important to check their ratings, which fall into two main categories: Investment grade and non-investment grade. Investment-grade bonds are of higher quality, typically viewed as very likely to pay their bondholders on time. Noninvestment- grade bonds (also known as high-yield or "junk" bonds) are less likely to meet their debt obligations and therefore carry greater risk. Corporate bonds with the best financial standing are rated "triple-A'.
"It is essential to assess the bond issuer's business background, credit quality, securitisation of bonds, and management profile. This could be a tedious exercise for a retail investor. We simplify this journey for retail investors through its in-house team that conducts detailed due diligence for all bonds curated on the platform. We only bring publicly listed senior secured bonds on our platform. A senior secured bond is backed by a pool of security, such as automobile, gold, or property loans. 'Senior' means bondholders are paid first if the issuer NBFC goes bankrupt." says Ajinkya Kulkarni, Co-Founder and CEO, Wint Wealth.
"The credit rating along with the credit rating outlook mostly solves this problem. One can get the credit rating report (mostly free) from credit rating agencies website and make a sense out about the bond's quality," adds Sharma.
So how are these bonds taxed if you decide to go for them? Interest earned on corporate bonds in India is subject to income tax based on the individual's tax slab. In the case bonds are listed, if the holding period is more than 12 months, the realised returns are termed LTCG which is taxed at 10% without indexation. When the holding period is below 12 months, individuals earn short term capital gains taxed at applicable slab rates.
SHOULD YOU INVEST NOW?
"Over the last year, the RBI has maintained the key interest rates on the higher side to fight retail inflation. Even in the August 2023 monetary policy review, the banking regulator kept the repo and the reverse repo rates unchanged. This means we are close to the end of the rate hike cycle. The market has been pricing in rate cuts from February to April 2024. Therefore, it is a good time for retail investors to lock in their desired fixed-income allocation in long-duration corporate bonds or bond funds. As the interest yields start falling, the capital appreciation of long-duration bonds can give good returns," says Kulkarni.
According to Bhuvanesh, investors should look at the difference in yields between similar maturities of government bonds and corporate bonds. "If there's a decent spread, it may make sense to invest in corporate bonds; if not, sticking to safe government bonds is better. Similarly, investors should also look at the difference between the interest rates of various maturities. In most market phases, the shorter maturity bonds tend to have lower interest rates, and longer maturity bonds tend to have higher interest rates. But there may be certain periods in which the difference between longer maturity rates and shorter maturity rates is less. In such cases, investors should consider the ideal maturity that works for them."
So how much should one allocate in such bonds? Experts advise an investor to allocate 10-15% of the total portfolio towards corporate bonds depending on financial goals, risk appetite, and other factors. One can spread this allocation across 5-7 issuers to reduce the risk further.