Investors are back to investing in non-convertible debentures (NCDs) after a lull in 2018. Consider this: In an environment of fear in the debt markets, not a single NCD issue failed in 2019 – all firms that offered these instruments managed to raise the base issue amount within the stipulated period. Investors clearly had an appetite for AAA-rated NCDs issued by top-notch names such as L&T Finance, Tata Capital Financial Services, Mahindra & Mahindra Financial Services.
According to PRIME Database, in 2019, 35 issues managed to raise in excess of 17000 crore. The number of issuances – higher than the number recorded in each of the preceding five years – must be seen in the context of the defaults registered by many corporate borrowers and serious risk aversion among fixed income investors.
Quality issues closed early on account of heavy investor participation. Issuers with AAA rating also managed to get subscription for the green-shoe component of the issue. The green-shoe option allows the issuer to retain additional amounts and allot extra units to subscribers.
“While AAA-rated issues were lapped up by individual investors, quickly leading to early closures, the bond issues with low ratings managed to go through with not much subscription above the base issue size in most cases,” says Vikram Dalal, founder and managing director, Synergee Capital Services.
Investors have been selective in picking up bonds, going by the figures provided by PRIME Database
The high number NCD issues can be attributed to multiple factors. “Non-banking finance companies (NBFCs) opted for the public issue route because funding from banks and mutual funds dried up after the series of credit crises, including those relating to IL&FS and DHFL,” says Dalal. Many NBFCs had opted to fund their long-term loan portfolios with short-term commercial papers issued to institutional investors such as mutual funds. As mutual funds went slow on investing in papers issued by NBFCs, they were forced to build the retail bond book by issuing instruments with various maturities. Given the restricted credit flow to NBFCs, this trend is likely to continue.
“The increase in the number of public issuances of bonds can partly be attributed to the regulatory requirement that large companies need to raise 25 per cent of their borrowings by issuing bonds,” says Joydeep Sen, founder of wiseinvestor.in.
Retail investors take to NCDs
Investors started warming up to these offerings.
“Individual investors’ investment time frame hovers around three to five years. If an asset class does not perform over that time period, they are likely to rotate the money. Tepid returns from equity mutual funds in the recent past made individual investors switch to NCDs that offered high single-digit returns,” says Anup Bhaiya, MD and CEO, Money Honey Financial Services. SIPs in diversified equity mutual funds, in most cases, have given single-digit returns over a three-year period. Small and mid-cap funds have generated losses for investors.
There was a 135 basis points cut in policy interest rates announced by the Reserve Bank of India. Banks gradually reduced interest rates on fixed deposits and loans.
“Interest rates on bank fixed deposits went down from (around) 8 per cent to 6.25 per cent over the past one and a half years. That made many fixed income seekers consider NCDs with high interest rates in the second half of the year. Investor apprehension about investing in bonds issued by NBFCs also reduced towards the end of the year,” says Anup Bhaiya. He points out that the spread between interest rates on nationalised banks’ fixed deposits and a good quality NCD was not as high in recent years. Thus these NCDs became an attractive investment option for many in the second half of 2019.
Where to invest?
The interest rate on offer from NCDs are also slowly inching downwards. For example, in December 2019, L&T Finance a AAA-rated issuer offered 8.45 per cent to retail investors under the annual interest payment option for a three-year tenure. The same stood at 8.9 per cent when it raised funds in April 2019.
Also, one should not ignore the potential of equity mutual funds to deliver returns. Investments in equity through the SIP route must be continued if an investor’s asset allocation pattern so demands.
However, if the asset allocation policy requires you to invest in fixed income, then do give a thought to risk appetite and cash-flow needs. “Investors should stick to bonds issued by companies with AAA or AA+ rating belonging to a reputed business house. Also one must diversify across issuers.,” says Joydeep Sen, founder of wiseinvestor.in.
Sen adds that in bond mutual funds, rules limit exposure to 10 per cent of money to one issuer. From a risk management point of view, one should not be investing more than 10 per cent of investible amount in the bonds of any issuer. The tenure of the bond should be based on one’s liquidity needs. Most listed NCDs are illiquid. And even if they trade, they do so at a discount to their fair values. Be prepared to hold on till maturity, in such cases.