Investors rarely have it this good when bonds and fixed deposits of companies yield between 11% and 12% a year
Fixed income investors are constantly in search of products that offer them higher interest rates. With interest rates inching up, company deposits and bonds have caught their attention. And guess what? They really have a lot to choose from these days.
Apart from the traditionally safe bank fixed deposits, today, there are company fixed deposits from the likes of Mahindra Finance and Shriram Transport offering 10.50% to 10.75% per annum. Some others, like Plethico Pharma, United Spirits and JaiPrakash Industries, are offering between 11% and 12%. Moreover, there are listed bonds from Tata Capital, L&T Finance and Shriram Transport, which give a yield of about 11% to 12% per annum.
You can, for example, buy a bond of Shriram Transport Finance – NG series, which has a duration of about 5 years 9 months, and a yield to maturity of 12.72%, or you can buy an L&T Finance – N5 bond, which has a duration of about 1 year, 9months and yield to maturity of 11.83%. The yields are about 100 to 250 basis points higher than that offered by bank fixed deposits.
HOW THEY WORK FOR YOU
You can invest in company deposits through a distributor or agent. Bonds, on the other, can be bought through a distributor only when there is an initial public offer (IPO). They are listed on the stock exchange after the IPO and can then be bought through a stock broker.
Company deposits give you the option of receiving income monthly, quarterly, half yearly, annually or on a cumulative basis. A bond gives you income in two ways. The first one is the coupon or the interest income, which could be payable monthly, half yearly or annually or on maturity. The SBI bonds, for example, pay interest annually. If you have invested . 10,000 in the 15-year bond, which has a coupon rate of 9.95%, you will get . 995 as interest income for every bond you hold in April every year till maturity.
The second way you could make money in bonds is through capital appreciation. For example, the first series of SBI bonds — N2 series were issued at . 10,000 and got listed at . 10,500, thereby providing a capital appreciation of . 500 per bond or 5% to investors. However, one must remember that this could work vice-versa, too. If interest rates were to move significantly upwards, as is the case now, the 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 . 970, lower than its issue price of . 1,000. The way out is to hold it till maturity. Then there is no interest rate risk.
Investors who plan to hold till maturity should buy these bonds. In case interest rates rise, there could be short-term mark-to market losses on your portfolio.
THE PROBLEM AREAS
Unlike mutual funds, which score high on liquidity, both bonds and company fixed deposits are illiquid. In the case of bonds, since the issuances have been small in size, once the initial sellers go away, trading becomes small or less, and, hence, exiting them could be difficult.
In the case of company deposits, premature withdrawal is not allowed before the completion of three months. If you wish to withdraw between the third and sixth months, you get zero interest income. If you wish to withdraw between the sixth and 12th months, you get 3% less than the guaranteed return.
Company fixed deposits are unsecured. In the case of bank fixed deposits, the Deposit Insurance and Credit Guarantee Corporation of India guarantees repayment of . 1 lakh in the case of a default. Company deposits offer no such guarantee and the safety of the fixed deposit depends on the financial position of the company. As a depositor with the company, you have no lien on any asset of the company in case it goes bankrupt. Your turn to get your money back would come only when secured lenders have been paid.
When it comes to tax, bonds are better than fixed deposits. If an investor holds a bond for a period of less than 12 months and books any gain, he is liable to pay a short-term tax. If he holds it for more than a year and then sells it, he is subject to long-term capital gain tax. Interest earned on the bonds comes under the income from other sources head and investors are liable to pay tax on it. Bonds are more liquid than FDs, are rated and secured. There is a chance to ride the interest rate cycle and take advantage by selling and booking profits.
HOW TO CHOOSE
While choosing company deposits, one has to be very careful. A corporate like HDFC offers you a 9.5% return, while smaller companies like Avon Corporation offer you an interest of 11% to 12% a year. Then there are some real estate companies which offer you as much as 12% per annum for a three-year deposit. However, since they are not rated, they are more risky.
The risk is even more when you are investing in smaller companies. Check the credentials of the promoters and their past track records.
It makes sense to invest in companies that pay dividends and are profit-making. Avoid loss-making companies or those who do not pay dividends. Also, it is important to check the servicing standards of the company. You should also know how quickly they dispatch interest warrants and the principal amount.
In the case of NBFCs, the RBI has made it mandatory to have an 'A' rating to be eligible to accept public deposits. Investors should go only for AAA- or AA-rated schemes. Go for shorter tenures such as one year to three years. Avoid deposit schemes of manufacturing companies which are not known or which do not have a track record. This way, you can keep a watch on the company's rating and servicing, and also have your money back in case of an emergency. Watch out for any adverse news on the company you have invested in and take necessary action if need be. Most companies accept fixed deposits for a period ranging from one year to five years.
Interest income from fixed deposits and bonds is taxable. So if you are in the highest tax bracket, weigh your options accordingly. If there is a probability you may need the money before a year, it is best not to park it in company fixed deposits.
Depending on an investor's risk appetite, they could consider putting 10% to 25% of their investments in fixed deposits and bonds for higher returns.
Diversify your money, spread it across companies, and do not put all the money in a single company.
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Also, know how to buy mutual funds online:
1) DSP BlackRock Mutual Funds:
http://prajnacapital.blogspot.com/2011/05/buying-dsp-blackrock-mutual-funds.html
2) Reliance Mutual Funds:
http://prajnacapital.blogspot.com/2011/06/buying-reliance-mutual-funds-online.html
3) Reliance Mutual Funds:
http://prajnacapital.blogspot.com/2011/07/buying-hdfc-mutual-funds-online.html
4) Sundaram Mutual Funds:
http://prajnacapital.blogspot.com/2011/07/buying-sundaram-mutual-funds-online.html
5) Birla Sunlife Mutual Funds:
http://prajnacapital.blogspot.com/2011/06/buying-birla-sunlife-mutual-funds.html
6) UTI Mutual Funds:
http://prajnacapital.blogspot.com/2011/06/buying-uti-mutual-funds-online.html
7) SBI Mutual Funds:
http://prajnacapital.blogspot.com/2011/06/buying-sbi-mutual-funds-online.html
8) Edelweiss Mutual Funds:
http://prajnacapital.blogspot.com/2011/06/buying-edelweiss-mutual-funds-online.html
9) IDFC Mutual Funds:
http://prajnacapital.blogspot.com/2011/06/buying-idfc-mutual-funds-online.html
