High inflation eats into your savings and at broader level it keeps interest rates in the economy high. Higher interest rates make it difficult for corporate and business houses to raise loans from banks. In a way, high inflation negatively affects both; individuals as well as corporate. Under such scenario, companies raise money directly from markets offering interest at a higher rate and individuals are tempted to invest in fixed deposits offered by corporate as the rate of interest on them is usually higher than that offered by banks deposits of similar tenure. Although there is no harm in lending money directly to the companies, one should not get carried away by high interest rates. You need to understand how to differentiate between a good fixed deposit scheme and a bad one.
You see, today companies which enjoy the status of Non-Banking Financial Companies (NBFCs) are allowed to accept fixed deposits from individuals. Many of NBFCs are dedicated to lend to a particular segment; say housing finance, motor loans and so on. Moreover, there are host of companies from manufacturing and services industries as well reaching out to public for need of funds. But before you get enticed by high rate of interest offered by a company, you need to assess the following parameters as well.
Purpose of raising money: It is not very uncommon to see financially weak companies accepting fixed deposits at higher rates to retire their old debts. Such companies may not be safe for you as money raised from you is unlikely to be used in any productive way. There's no guarantee that retiring old debt will help in improving balance sheet. Similarly the companies raising money to meet working capital requirements may also be under financial stress and thus not ideal for investment.
Current debt on books and Credit history: It is important for you to carefully analyse the past track record of the company in servicing debt. You must assess how company has used debt it raised in the past and how much value it has added to its business. Successful track record on this front would entail that the company has been efficient not only in servicing debt but also in making optimum use of resources.
Predictability of future earnings: Under normal circumstances, the debt is served through profits earned through business activities. Hence it is imperative for you to know if the profits of the company are predictable. Sensitivity of the business to the performance of economy or cyclical nature of its business may make the company vulnerable in a cyclical downtrend and may put strain on its finances.
Although credit ratings given by independent rating agencies take all the above mentioned aspects into consideration before awarding any rating to the company; you should not depend only on ratings given by them. In case the scheme which you are considering for investments are rated by any independent rating agency, you must check the past record of the rater as well. Usually, it is the company which pays for the services offered by the agency.
PersonalFN is of the view that, you should not chase returns and always do a careful assessment on your own. These days, when even banks are finding it difficult to recover their dues from borrowers and have been allowing restructuring of loans worth thousands of crore; you, as an individual, may not be well place to handle any situation where the company has not paid interest or principal or both.
Remember, role of fixed income bearing instruments in your portfolio is not to maximise profit. By generating regular flow of income, they function as a portfolio balancer. You should be better off if you stick to your customised asset allocation designed to help you in achieving your long term goals.
PersonalFN is a Mumbai based Financial Planning and Mutual Fund Research Firm.