You can invest up to 10% of your portfolio in these debentures only if you plan to hold them till maturity,
Investors know that the days of double-digit returns are going to be over soon. And they are busy chasing instruments that can still provide 10%-plus returns before interest rates start coming down. At the moment, NCDs of Shriram Transport, Shriram City Union Finance, Muthoot Finance, Manappuram Finance, IIFL, Religare Finvest, among others, trading in the secondary market are on their radar – these NCDs offer a yield of 10-14%, around 1.5-4.0% higher than regular fixed deposits. For example, State Bank of India pays a maximum interest of 8.5% on FDs, whereas an NCD of IIFL – N4, which will redeem in August 2016 and pays an interest of 11.80% per annum, is currently trading at . 1,022, giving an yield of 14.10%. Shriram City Union Finance – N3, which pays an annual interest of 12.1% and matures in August2016,tradesat. 1,077,offeringan yield of 12.18%.
“If you want to earn a higher interest on your investments and plan to hold them till maturity, you could invest in these NCDs. However, if interest rates fall, capital appreciation is unlikely due to the lower tenure of these bonds. Also, remember that they carry a lower rating than PSU bonds and hence a higher risk,” says Vikram Dalal, managing director, Synergee Capital.
Indeed, the residual (remaining) tenure of these NCDs is low and could be anywhere between six months and four years. That means, once these NCDs mature, you may be exposed to reinvestment risk. Also, they are lower rated and could prove risky. “Since NBFCs carry higher risk, don’t allocate more than 10% of your debt portfolio to such instruments,” says Deepak Punjwani, head (debt), GEPL Capital.
NO CAPITAL APPRECIATION “If you are looking to play the interest rate cycle and make a capital appreciation in the process, short- tenure bonds will not work for you,” says Vikram Dalal. That means you should invest in these bonds only if you are prepared to hold them till maturity. This is because bonds are expected to make capital gains when interest rates fall, but these bonds may not make any gains because of the short residual tenure.
“Interest rates are expected to go down by 50 to 100 basis points (1%=100basispoints)inthenextone year,” says Deepak Punjwani. When interest rates fall, bond prices of long-tenure and higher-rated papers will move up much more than shorter-tenure papers. So if interest rates were to fall by 100 basis points, a 15-year bond will appreciate by . 10, while a 10-year bond will appreciate by . 7, and a bond with tenure less than5-yearswouldshowtheleastappreciation of . 3 to . 5. So, the 8.3% NHAI 2027 bond, which trades at . 1,078 and has 14 years to mature, could show an appreciation of . 10 and trade at . 1,088. As compared to this, the IIFL- N4 which trades at . 1,011 and matures in August 2016 may give you an appreciation of merely . 3.
KEEP THE TAXATION ANGLE IN MIND If youbuyabondwhichhaslessthan a year to go for maturity and is in the hightaxbracket,youwillenduppaying short-term capital gains tax on the same, which will bring down your post-tax returns. For example, Muthoot Finance – N2 matures in September 2013. The NCD pays 12% interest and trades at . 1,011, giving youayieldof 13.86%.Now,if youpay 30.6% tax on this, your ultimate return will be only 9.62%.
BEWARE OF THE RISKS These NCDs which offer you yields ranging between 10% and 14% are from NBFCs, which carry higher risk and have a lower rating as compared to PSUs. Some of them are into single businesses like gold loan financing.
“Some NBFCs offer financing to real estate developers. In today’s real estate scenario, this is particularly risky as security against these loans is quite illiquid.” says Kunal Pawaskar, founder of Capital Orbit. He advises investors to read the risk factors in NCD prospectus, learn about thebusinessandthentakeadecision on whether to invest or not.
He advises investors to allocate only 5-10% of their portfolio to such NBFC NCDs. “Due to their small issue sizes, these NCDs are illiquid and witness thin trading volumes. Hence investors should buy them with an objective of holding till maturity,” says Deepak Punjwani.
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