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Investment in quality bonds can be as rewarding as equities

Bonds are often overlooked by investors as an investment asset. The main reason for this is that the investors perceive the coupon offered by bonds as the only form of return that bonds offer. However, bond investment can be indeed very rewarding if it is sold at appropriate time in the secondary market, reckons Vivek Sharma.

June 03, 2013 / 01:07 PM IST

Investors often ignore bonds as an investment asset. There are many reasons for the same. But the main reason is the fact that investors perceive the coupon offered by bonds as the only form of return that bonds offer. As a result of this, coupon offered by bond is often compared with traditional investment options like PPF, bank deposits etc. and investment in bonds are overlooked. However, returns from bonds do not get generated from coupon alone. There are several other drivers of bond’s price like credit quality of bond, prevailing yield in the bond market, tenor of the bond etc. Change in the rate of interest over a period of time also significantly impacts bond price and the return that an investor gets from bond investment. In fact in a falling interest rate scenario, like the one which we have in India now, investment in bonds have provided significant return from the price appreciation that bonds have given.

In order to understand this let us go back to 25th January, 2012 when NHAI issued 15 years bond offering coupon paying 8.30% coupon.  The coupon payment on these bonds has an annual frequency and the first coupon date was set as 01-Oct-2012 and subsequently on 1st Oct every year till maturity date of 25-Jan-2027. Now imagine an investor had purchased these bonds thinking that he will get coupon payment till 2027 @ of 8.3% per annum which will be totally tax free. Is return for investor confined to this coupon payment alone? The answer is yes if he holds the bonds till maturity and no, if he decides to sell these bonds. Let us look at the second scenario.

Now let us see how selling the bond will generate more return for the investor. NHAI bonds are tradeable in the corporate bond segment of NSE. These bonds are traded on dirty price and settled on dirty price only.(, Refer page number 10 of the document for trading and settlement price) .Also liquidity in these bonds is decent though not ideal or like government securities. This means that the buyer pays the price at which bond was traded in the market to the seller (holder) of the bond. Generally calculation of accrued interest is done for bond’s settlement price along with the clean price to arrive at final settlement price which is not the case here.

Now let us look at the traded price of NHAI bonds to understand how an investor can make maximum from selling these bonds. Highest traded price of these bonds was Rs. 1179 on 28th May and last traded price was Rs.1176.  Now imagine that the investor was able to sell, these bonds on the last traded price. In that case, the total cash flow received by investor will be as follows:

- Coupon received on the bonds from 25th January, 2012 to 1st Oct,2012 which works out to be around 57 rupees on a coupon of 8.3% for 250 days

- Selling price of 1176 from the bond.

Considering these two cash inflows against the cash outflow of Rs. 1000 at the time of investment, the total return generated from investment works out to be around 17.28 percent for around one year and four months investment. This is an extremely good return by any standard even compared with equity market return.

An important point to remember here is while the coupon payment on these bonds is tax exempt, the capital gains is not. Since the investment in bond has been made for more than a year, the bond will qualify for long term capital gains which can be applied as 10% without any indexation benefit. The total capital gains from the bond investment are Rs.176 (selling price 1176 minus purchase price 1000) which classifies as capital gains. This means that Rs. 17.6 will classify as capital gains. The remaining part will be retained by the investor. The total return from bond investment will be 16% post tax for the investor. Please note that the coupon payment is tax free and hence has not been considered in the capital gains calculation. Also transaction cost has been ignored in absence of a reliable benchmark.

In the days to come the return from this bond is going to be higher than the current return. There is an expectation of interest rate cut during coming days which may provide higher return as the price increases.  Bond investment is indeed very rewarding and more rewarding if the bond is sold at appropriate time in the second market.  The most important to note is that this is not the case with NHAI bonds but also applicable in case of other bonds issued by SBI, HUDCO, REC etc.

first published: Jun 3, 2013 12:27 pm

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