Introduction

Non-Investment Grade Bonds, also known as high-yield bonds or junk bonds, are debt instruments issued by entities that carry lower credit ratings than investment-grade bonds. These bonds are rated below 'BBB-' (by CRISIL, ICRA, CARE) in India or below 'Baa3' by Moody’s internationally. They offer higher interest rates to compensate for their elevated credit risk, making them attractive to investors seeking aggressive returns, but with a greater appetite for volatility and potential default.

Understanding Non-Investment Grade Bonds

Unlike their investment-grade counterparts, which are considered safer and more stable, non-investment grade bonds are issued by companies or institutions with weaker financial health, limited operating history, or high levels of debt. While they offer potentially lucrative returns, they also carry a significantly higher risk of default, meaning the issuer may be unable to pay interest or principal on time.

Credit Ratings and Classification

In the Indian context, credit rating agencies such as CRISIL, ICRA, and CARE Ratings assess and assign ratings to bonds. Bonds with the following ratings are considered non-investment grade:

• BB+, BB, BB-
• B+, B, B-
• CCC, CC, C, D (default)

These ratings indicate speculative or poor credit quality, and are often assigned to start-ups, small enterprises, financially distressed companies, or companies in emerging sectors.

Features of Non-Investment Grade Bonds

• Higher Yields: To attract investors, issuers offer above-market interest rates.
• Increased Credit Risk: Higher probability of payment delays or defaults.
• Lower Liquidity: These bonds are less actively traded, especially in the Indian bond market.
• Higher Volatility: Their prices can fluctuate more with changes in company performance or market conditions.
• Shorter Maturities: Some high-yield bonds come with shorter tenures, though this varies by issuer.

Who Issues Non-Investment Grade Bonds?

• Mid-cap or small-cap companies looking to raise capital.
• Start-ups or early-stage firms with limited access to bank financing.
• Corporates under financial restructuring or with ongoing operational challenges.
• In some cases, even larger firms with stressed financials issue these bonds to manage cash flows.

Why Investors Consider Non-Investment Grade Bonds

Despite the risks, these bonds are favoured by:

• Yield-seeking investors looking for returns beyond traditional debt products.
• Institutional players who can afford to absorb credit risk and conduct in-depth due diligence.
• Mutual fund schemes, such as credit risk funds, which selectively invest in lower-rated papers to generate higher returns.

Risks Associated with Non-Investment Grade Bonds

• Default Risk: The most significant risk, where the issuer fails to repay.
• Credit Downgrade Risk: Further downgrades can erode the bond’s value.
• Liquidity Risk: Difficulty in selling the bond in the secondary market.
• Reinvestment Risk: If the bond is called or matures early, reinvesting at the same high yield may not be feasible.
• Market Sentiment Impact: During market stress, non-investment grade bonds are the first to be sold off, worsening their prices.

Mitigating Risk in India

Investors can manage their exposure to such bonds by:

• Diversifying across issuers and sectors
• Limiting allocation to a portion of the portfolio
• Monitoring credit ratings regularly
• Evaluating the issuer’s financials, business model, and future prospects
• Investing through debt mutual funds or PMS strategies that have professional credit research teams

Non-Investment Grade Bonds vs Investment Grade Bonds

Regulatory Oversight in India

SEBI has laid down stringent norms for:

• Disclosure requirements in bond issues.
• Valuation norms for debt securities.
• Risk labelling in debt mutual funds, particularly for credit risk funds.
• Additionally, credit rating agencies are regularly reviewed to ensure transparency and reliability in bond evaluations.

Conclusion

Non-Investment Grade Bonds offer high returns, but with substantially higher risk. While they can enhance portfolio returns, especially in a falling interest rate environment, they require careful selection, monitoring, and risk management. For Indian investors, these bonds are best approached through diversified instruments like mutual funds or under the advice of professionals, given the complexity of assessing creditworthiness.

A sound understanding of one’s risk appetite, investment horizon, and the issuer’s fundamentals is essential before allocating capital to non-investment grade securities.