With the Reserve Bank of India (RBI) urging non-banking financial companies (NBFCs) to reduce their dependence on banks and mutual funds turning conservative after the Franklin Templeton incident, NBFCs are increasingly turning to the bond market to raise funds. According to the PRIME database, they have raised Rs 73,820 crore through corporate bonds since August 1, 2024. This surge in bond issuance offers opportunities to retail investors, especially with the minimum investment limit being reduced from Rs 1 lakh to Rs 10,000.
Attractive opportunities
With more NBFCs tapping the bond market, interest rates are currently attractive.
“The US Federal Reserve has cut interest rates by 50 basis points. The Reserve Bank of India is likely to follow suit in a quarter or two. Therefore, it makes sense to maintain the current elevated rates,” says Anshul Gupta, co-founder and chief investment officer, Wint Wealth.
Vishal Goenka, co-founder of IndiaBonds.com, points out that as central banks are likely to reverse the rate cycle soon, bond prices could appreciate, resulting in capital gains for investors.
“Corporate bonds, particularly those with a three- or five-year maturity, offer good opportunities. Even AAA-rated bonds offer a yield close to 7.5%, at least 300 basis points above expected inflation,” says Sandeep Bagla, CEO, Trust Mutual Fund.
Wint Wealth’s Gupta adds that bonds with slightly higher risk can offer double-digit returns, beating the 7-7.5 per cent offered by bank fixed deposits.
Investing in stability
Higher-rated bonds tend to be safer and less volatile. “They can offer a stable and predictable income stream, which is essential for those looking for regular payments,” Goenka says.
Bonds provide stability to a portfolio, which is especially valuable during phases of market volatility.
Investors now also have a wide range of issuers, tenors and risk profiles to choose from.
Risks to consider
A key risk is interest rate risk: if the Reserve Bank of India raises rates, the value of existing bonds falls. “Long-term bonds are more sensitive to changes in interest rates,” says Ankit Gupta, founding director of BondsIndia.
In addition, there is the credit risk, which is particularly high for bonds with lower ratings. “Bonds also carry the risk of having their ratings downgraded due to worsening financial conditions,” says Bagla.
Liquidity is another factor, as lower-rated bonds can be difficult to sell. Bonds also carry reinvestment risk. “If they mature or are called early, you may not be able to reinvest at the same pace, especially in a low-interest rate environment,” says BondsIndia’s Gupta.
Run these checks
When evaluating bonds, yield shouldn’t be the only factor. Pay close attention to the bond’s credit rating. Ideally, it should be AA or higher. “Higher ratings mean a lower risk of default,” says Goenka.
Review the issuer’s financial data, including its debt levels. “Check who else is lending. If there are major lenders involved, they’ve likely done their due diligence,” says Wint Wealth’s Gupta.
Consider whether the bond’s interest rate is fixed or floating, as this affects returns in a changing rate environment.
If the bond is callable, be careful. BondsIndia’s Gupta warns that if the issuer calls it early, that could hurt its long-term return potential.
Avoid bonds with long maturities. Wint Wealth’s Gupta recommends a one- to two-year maturity to reduce the risk of default due to worsening financial conditions.
Avoid investing in bonds offering yields above 12 percent. Wint Wealth’s Gupta sees such rates as a red flag.
Finally, diversify investments across multiple issuers and sectors.
First published: September 20, 2024 | 19:40 IS
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