Bonds have caught the attention of fixed income investors lately. There has been a mad scramble from retail as well as high net worth investors (HNIs) to grab these bonds issued by Tata Capital, Shriram Transport, L&T Finance and State Bank of India. If you missed out on the opportunity to buy them, you can buy them from the stock exchange as these bonds are listed and are traded in the secondary market. For example you can buy a bond of Shriram Transport Finance – NF series (with a duration of 5.73 years and the yield-to-maturity of 12.83%) or L&T Finance – N5 bond (duration of 1.88 years and the yield-to-maturity of 11.37% (see table for more such options) from the secondary market. The yields are around 100-200 basis points higher than currently offered by bank fixed deposits. Investors with a higher appetite for bonds can look at buying them from the secondary markets, given the attractive yields.
HOW TO BUY BONDS
There are two ways in which you can buy these bonds. One is at the time of primary issue. The past two years have seen issuances from Tata Capital, Shriram Transport Finance, L&T Finance and State Bank of India (SBI), with offerings from the likes of Shriram Transport Finance and SBI getting oversubscribed on the first day itself. SBI's latest issue, which offered coupon rates of 9.95% for 15 years and 9.75% for 10 years to retail investors closed on February 28, saw a massive over-subscription of 8.5 times. Investor participation in all these has been quite encouraging and all these issues were oversubscribed and were focused to get retail money by way of having higher reservation or differential pricing for retail. The easiest way for investors is to subscribe when the issue is on. A reputed organisation like SBI offering interest rates of 9.95%, as it did in the recently closed issue, was a good option to subscribe to, he adds. However, even if you subscribe at the time of the primary issue, there is no guarantee that you will get allotment, as some of the issues have been fully subscribed on the opening day itself. In such a scenario, the other option is to buy these bonds from the secondary market, through your stock broker — the way you buy and sell shares.
INCOME AND RISK FACTORS
There are two ways in which you can make money on a bond. The first one is the coupon or the interest income. Some bonds pay a half yearly or an annual interest, while some pay it on maturity. You should choose the bond, depending on your needs. For example, the SBI bond series, which closed for subscription in February, will pay the interest annually. So, if you have invested . 10,000 in the 15-year bond, you will get . 995 as interest income in April every year. You could also make money in bonds by way of capital appreciation. For example, the first series of SBI bonds N2 series were issued at . 10,000 and got listed at . 10,500, offering a capital appreciation of 5% to investors. However, one must remember that this could work vice versa, too. If interest rates were to move significantly upwards, bond prices could move down. For example, the L&T Capital N5 option, with an 8.4% coupon, with interest payable on a half-yearly basis, now trades at . 953, lower than its issue price of . 1,000.
One simple way is to hold the bond till maturity, as there is no interest rate risk. However, the price in the stock market may depend on interest rate movements. For example, the L&T bond is trading at a discount to the issue price because of the hardening of interest rates. This is because bond prices and interest rates are inversely correlated. So when interest rates move up, bond prices move down and vice versa. In addition, some of these bonds have put and call options. For example, the issuer of a bond with a call option may call back the bond if there is a dramatic fall in interest rates. Similarly, if you are invested in a bond with a put option, you can give it back to the issuer if interest rates move up significantly. If the option is exercised by the issuer, there is a reinvestment risk. Bonds are also illiquid in nature.
Since the issuances have been small in size, once the initial sellers go away, trading becomes infrequent When interest rates go up, there could be short-term mark-to-market losses on your portfolio. However if you are a long-term investor you need not worry about these losses. These bonds are liquid and a better option than the fixed deposits. Here you can ride on the interest rate cycles and take advantage by selling at the right point to book profits or generate the desired liquidity. As far as taxation is concerned, bonds are better compared to fixed deposits. If you hold a bond for a period of less than 12 months and book any gain, you will be liable to pay a maximum short-term capital gain tax of 30.6%. If you hold it for more than a year, and then sell it, you will be subject to long-term capital-gain tax, which is lower of 20.6% with indexation or 10.3% without indexation. The interest earned on bonds comes under income from the 'other sources' category and you will be liable to pay tax on the same.
THE PROS AND CONS
There are several advantages of buying these bonds. One, there is a plethora of choices available. In the secondary market, you have products available with duration varying from two years to 15 years. Some like SBI are long-term instruments with a maturity option of 15 years. Post office instruments have a maturity period of 5-6 years, while bank deposits are at best offered for a 10-year tenure. These bonds give you an option to hold on to long-term instruments. Another advantage is that most of the bond issuances come from good issuers. Most of these retail issuances have so far been issued by reputed safe issuers like L&T, Tata, SBI and Shriram etc. All were secured except SBI which is a AAA-rated PSU bank and security for such credit quality is irrelevant. So from the point of view of safety, there is no doubt.
However, some feel debt mutual funds offer better choices to retail investors and are easy to transact in. Debt funds are easy to transact and you can buy or sell on any given day.
On the liquidity front, it's a mixed bag. While these bonds are listed, due to their small issue size, trading is less and you may not always get the liquidity you desire. Liquidity in the initial period of the listing is excellent and bonds are traded at a very narrow spread. There are many investors who do not get allotment or miss out, and want to buy a bond. Slowly, over a period, as it gets consolidated and traders stop getting supply on screen, it starts getting illiquid. Compared to a bank or company fixed deposit or a post office monthly income plan (MIP), where you may have to pay a penalty in case you want to break your deposit, here you have the option to sell the bond on the stock exchange.
Investors can build their bond portfolio slowly over a period of time. We recommend investors to have around 25% of their portfolio in products where investment risk is minimal and these bonds will fall in that category. However, do note that these bonds are very different from the tax-saving infrastructure bonds available in the market. These bonds do not offer any tax benefits, nor do they have a mandatory lock-in period of five years like tax-saving infrastructure bonds.
