After the equity rush by retail investors, fintechs see bonds taking off

Sebi regulations will likely increase the retail participation in bonds

Two years ago, when market regulator Securities and Exchange Board of India (Sebi) changed the face value of bond investment from Rs 10 lakh to Rs 1 lakh, retail participation grew from one percent to four percent in a matter of few months, according to a consultation paper by Sebi.

Earlier this month, Sebi allowed companies to issue bonds with a minimum face value of Rs 10,000. Bond marketplaces and other investment platform fintechs that plan to enter the segment later this year expect this development to open the floodgates for bond investment from retail investors, similar to the consumer interest in equity seen during the Covid lockdown period and thereafter.

The bond marketplaces expect retail participation to grow from 4 percent now to around 10-12 percent within the next two years. According to these firms, there are around five to six lakh retail bond investors in the country, which is expected to grow to around two million over the next three years.

“This bond investment gives 50 percent higher returns than fixed deposits (FDs) with lower risks than equity and also brings certainty to the returns. With this move Sebi is giving investors a clear alternative to FDs,” says Nikhil Aggarwal, Founder and CEO of Grip Invest, a bond marketplace.

While bonds by government and large corporations with high rating yield rates of around 7-10 percent, most bonds usually yield rates upwards of 12 percent, much higher than FDs

When the minimum investment amount was higher, high-net-worth individuals and non-resident Indians were the major individual investors. The annual bond market in India is estimated to be around $20 billion.

Two years ago, Sebi mandated that companies secure an online bond platform provider (OBPP) license to sell bonds to customers. While this increased the cost of operation, it helped build investor confidence in such platforms, says Aggarwal of Grip.

Grip has raised Rs 100 crore from venture capital firms such as Anicut Capital, Endiya Partners, Stride Ventures  and Venture Highway among others.

There are around 15 companies that have got OBPP licenses and among those are Wint Wealth, GoldenPi, Indiabonds, Bondskart and The Fixed Income among others. A few mutual funds platforms and fixed-income start-ups are also looking to enter the space later this year.

Giving choice

"We have always believed that bonds and maybe not stocks are the right stepping stone for most Indians - better than FD returns but lower risk than stocks. But bonds have been an HNI product, and no one sold them to retail. As retail demand increases, we should hopefully see more bond issues with smaller face values," Zerodha founder Nithin Kamath said in a LinkedIn post two weeks ago.

Interestingly, Zerodha founders’ Rainmatter Capital has invested in two of the bond marketplaces namely GoldenPi and Wint Wealth; a third investee company smallcase, a platform for investment advisors and mutual funds, is expected to launch bonds later this year.

The minimum investment change is expected to be implemented from Q2 of the current financial year.

“There has to be a spectrum of products catering to all customer needs and there will be a market for all of those with different risk weightage from equity to sovereign gold bonds, government securities and corporate bonds to FDs. FD is a simple product while bonds are deeper products for investors looking beyond FDs,” says Ajinkya Kulkarni, CEO and Co-founder of Wint Wealth.

Kulkarni compares this moment with that of mutual funds, which have seen mass adoption since Covid because of the regulatory changes that made mutual fund investing accessible, fraud-free and easy to invest in.

“For the past two years, regulators are taking all the signals from various market players to shape the bond industry in the best possible way,” says Kulkarni adding that this is probably the most important regulatory change helping the bond markets.

Stable Money, one of the fixed-income portals that is currently aggregating high-interest FDs is set to launch its bond platform later this year after the company secured an OBPP license early this year. Its Co-founder Saurabh Jain says that the company is hopeful of the segment growing much faster than until now. “We have got good tailwinds on this,” he adds.

Addressing liquidity

Bonds offered on these platforms generally include bank bonds, PSU bonds, government guarantee bonds, state development loans (SDL), sovereign gold bonds, real estate bonds, and public issue of bonds, among others.

While a four percent retail participation in bonds might seem small, even in the equity market, retail participation is only 14 percent. So, if this figure grows to 10-12 percent, that will address a few challenges that the bond market faces today.

One of the biggest challenges is that it is typically illiquid and is not easily traded, unlike the equity markets. Because of this nature, most of the bond marketplaces buy bonds at a discount from issuers and then sell them to retail investors at the market price, the difference being the margin.

“Most of the players end up following the business model as the bonds will not be available when retail investors enter the market. However, this does offer an additional margin opportunity to us,” says Aggarwal.

Kulkarni of Wint Wealth feels that as more customers enter the market, liquidity will slowly come to the market as not every investor will want to hold the full bond investment for the entire duration of 8-10 years.

“The liquidity will attract more customers gradually,” says Kulkarni.

More challenges remain

While fixed returns might be a huge advantage for bonds vis-a-vis equity, the tax rates mean that it is considered unfavourable by anyone falling in the income tax bracket. For instance, the interest income earned from bonds is charged as per the income tax bracket, which could be 30 percent for most of the typical bond investors today. Meanwhile, long-term capital gains are taxed at 10 percent of the profits.

“The tax arbitrage gives equity an unfair advantage and we are hoping that this will be sorted by Sebi and government over the next few years and there are a few discussions that happened,” says Kulkarni.

To be sure, dividends are taxed as income, but over the last two decades it has become rare for companies to offer hefty dividends and investors buy equity mostly for price appreciation.

Considering that bonds are fixed income, the product’s biggest competitor is FDs. Some of the safest bonds get interest rates in the range of 8.5 percent to 10 percent, which is not far from what the FDs in small finance banks (SFBs) generate.

“Here again, the regulatory arbitrage ensures that FDs up to Rs 5 lakh are insured and customer money is always safe while even the safest bonds have one percent risk of default, putting the bonds at a disadvantage,” Kulkarni says adding that the Reserve Bank of India ensures that banks don’t fail, giving customers confidence in investing in FDs.

But as Indian customers' disposable income increases and investors look for diversification, bonds are likely to feature prominently given the substantially higher interest rate, say the fintechs.