Why Now is the Right Time to Look at Bonds

Investing in Fixed Deposits (FDs) is a habit passed down through generations in India. Our parents and grandparents were taught to trust the bank, and for good reason. For a long time, FDs have been the go-to investment option for thousands of Indian households as they are considered to be ‘safe’, often offering a guaranteed return with a low risk profile. However, as our options expand, it is imperative for investors to look beyond traditional instruments and explore options that offer potentially higher returns, better tax efficiency and greater flexibility.

The maiden episode of Mint Bond Street Dialogues saw Vishal Goenka, Co-Founder, IndiaBonds in conversation with Neil Borate, Editor-in-Chief, thefynprint. Goenka spoke about fixed income investing options that go beyond the humble FD.

Watch the full interview below,

Borate started the discussion with a fundamental understanding of fixed income. In simple terms, fixed income instruments are a loan you provide to an entity, such as a company or the government, in exchange for regular interest payments and the return of your principal at the time of maturity. While FDs are one form of this, they are just the starting point. FDs are the very basic form of savings. When you put money in a fixed deposit, you are essentially lending to the bank. The bank, in turn, takes this money and lends it to corporates or individuals at a higher interest rate, making a profit.

“Most Indians, I think, begin with fixed deposits and each instrument has its pros and cons. In my view, fixed deposits are extremely simple, easy to understand. One disadvantage is that they are fully taxable, so people at higher slabs have issues,” Borate said.

When you invest directly into fixed income or bonds, you make your own choice of where to lend and in the process earn potentially higher interest rates than fixed deposits. Other common fixed income options include the Public Provident Fund (PPF) and Employee Provident Fund (EPF). “Both of these are essentially government instruments. They have tax advantages. So PPF has a 7.1% interest currently tax free. EPF has an 8.25 interest currently, which is also tax free,” Goenka explained.

However, these instruments are structurally illiquid, with lock-in periods of 7 to 15 years and also non-transferable. This lack of liquidity can be a major disadvantage if you need access to your funds unexpectedly.

Another popular alternative in the fixed income space is debt mutual funds. The main advantage of debt funds is that they provide a diversified portfolio of bonds, which are managed by professionals. Furthermore, they offered tax benefits through indexation, though this has largely been removed. While they are great for managing liquidity and short-term capital needs, they might not offer the same level of granular control or potential for higher returns as individual bonds.

Fixed income investments are must-haves in a well-balanced portfolio, according to Goenka. He said: “The primary question is that everyone should have fixed income in the portfolio. People already have fixed income in the portfolio, and they don’t know about it.”

For a segment of investors seeking greater control, transparency and potentially higher returns, investing in individual bonds is a compelling alternative to other forms of fixed income. Once considered the exclusive domain of institutional investors, bonds have become more accessible to individual investors owing to the rise of online bond platforms. These regulated platforms, sanctioned by Securities and Exchange Board of India (SEBI), offer retail investors the chance to buy and sell individual bonds with ease. However, Goenka strongly advises caution

“Please only buy from regulated platforms. There are a lot of platforms which sell various kinds of financial security, calling it fixed income. Just check there’s a list. Make sure the platform you buy is regulated. Secondly, just make sure you buy listed securities or listed bonds,” he said.

Investing into the bond market requires some understanding of a few key concepts. Goenka detailed the essential factors for new investors.

The first step is to match your investment horizon to the bond’s maturity. Investors must align the investment with their personal financial goals. Do you need the money for a short-term goal, like a car purchase in three years, or a long-term one, like retirement in 15 years? If you have a specific life event in mind, like buying a house, you can purchase bonds that mature at that exact time, ensuring your funds are available when you need them without the risk of market volatility.

Understanding the difference between thecouponand theyield to maturity (YTM)is also important. The coupon is the fixed interest rate the bond issuer promises to pay, much like an interest rate on an FD. However, the YTM is the actual return you will receive if you buy the bond today and hold it until it matures. This is the figure that truly matters. A bond can be bought at its original price (par), at a premium (above par), or at a discount (below par). Goenka explained: “If you have bought a bond above par, your yield or return will be lower than the coupon. And if you buy a bond below par, then its returns or yield goes higher.” All SEBI-regulated platforms are now mandated to display the YTM of a bond, making this crucial information easily accessible to investors.

Another critical factor is thecredit rating. Interestingly, he used the analogy of a school report card for a company. Every listed bond is rated by a SEBI-regulated credit rating agency, which assesses the issuer’s financial health and its ability to pay back its debt. Ratings range from triple-A (AAA) for the safest, typically large public sector enterprises, down to lower grades. Within the investment-grade category alone, there are 10 layers of risk profiling. Goenka advised individual investors to stick to higher-rated bonds, as they offer a better balance of risk and return.

“I really discourage buying triple B minus or below, and they are a very small segment of the entire bond market. The credit rating will tell you, and typically in the current market scenario, for example, triple A, double A plus gives you 6-7%, double A plus will give you about 8%, Single A is where you get with a little riskier territory, starts giving you 10% if a person picks a triple B minus at 13% there is a reason why it is at 13% and it is the riskiest of the 10 rating structures. So match your investment profile,” he said. While credit ratings provide a good guideline, they are not absolute and can change based on the company’s performance and economic conditions.

Bond prices are directly influenced by interest rates, and this is a relationship that smart investors can use to their advantage. The relationship is inverse: when interest rates rise, bond prices fall, and when they fall, bond prices rise. The reason is simple. A bond issued at a higher coupon rate becomes more valuable when new bonds are being issued at a lower rate. This can lead to capital gains for the investor.

Goenka points out that in the current environment, with interest rates on a potential downward cycle, it’s a favourable time for fixed income investments. This is because existing bonds with higher coupon rates will see their prices appreciate. This means investors could potentially earn capital gains in addition to the regular interest payments.

“India has just entered a rate cutting cycle.. I would think that we were to hold interest rate steady or downward for at least next two years. So it is a good time in the interest rate cycle,” he explained, making it a good time for fixed income investors to enter the market.

Goenka concluded the discussion by reaffirming the importance of bonds in an investor’s portfolio. “fixed income or bonds, I think are a must in every portfolio... You always make sure 20-30% of your portfolios are in fixed income assets to get you stable returns,” he said.

He encouraged investors to do their own research, read the information memorandum of the issuer, and compare prices across different platforms. “The power of information is the most important aspect in making a financial decision, or transparency, as we call it. So before you invest, you can actually check, and you should read the credit rating of the issuer, the Information Memorandum of the issuer,” he said.

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