In the hustle and bustle of India's financial world, the Indian Bond Market stands tall as a reliable pathway for growth and opportunity. In the last ten years, it has not just survived but thrived, especially with more retail participants getting involved. Recent government moves, like SEBI's proposal to make bonds more accessible by reducing the minimum investment from Rs 1 lakh to Rs 10,000, the facilitation of the Retail Direct Platform, introduction of simpler and more accessible bond products, is a hint at even better times ahead for the bond market.
After SEBI's changes, reports show that everyday investors have jumped into the bond market, going from a small 0.7⁒ in FY '22 to 2⁒ in FY '23, and now sitting at 4⁒. This tells us something big is happening. Traditionally, people leaned towards stocks, but now, with a growing understanding of the benefits of corporate bonds, more and more folks are joining the bond market bandwagon.
In this article, we will take a detailed look at why Investing in corporate bonds offers a range of advantages for individual investors, providing a compelling alternative to other investment options so that you can ride the wave of corporate bonds and benefit from its growth and stability.
What Are Corporate Bonds?
Corporate Bonds are a debt instrument that is issued by a company to raise money. The company(bond issuer) gets the money it requires through investors(bondholders) who invest in the bond and in return the issuer pays annual or periodical payments at a fixed or variable rate of interest called coupon payments.
For eg: If you invest Rs1,000 in a 10-year bond paying 5⁒ fixed interest, the company will pay Rs 50 per year as coupon payments and give back the principal amount i.e. Rs 1000 after the bond matures i.e. in 10 years.
Also Read:Understanding The Settlement Process for Corporate Bonds
Types of Corporate Bonds Available in India
Corporate bonds are demarcated by their maturity and Coupon payments in India.
Secured Corporate Bonds
Backed by Assets: Secured corporate bonds are backed by specific assets of the issuing company. In case of default, bondholders have a claim on these assets, providing an added layer of security.
Low Risk and Low Returns: Due to the asset backing, secured corporate bonds are generally considered lower risk compared to unsecured bonds.
Unsecured Corporate Bonds
No Specific Collateral: Unsecured corporate bonds do not have specific assets pledged as collateral. Bondholders rely solely on the company's creditworthiness and ability to fulfill its payment obligations.
Higher Risk and Potential Returns: Since there is no collateral, unsecured bonds are generally considered riskier, but they may offer higher yields to compensate for the increased risk.
Convertible Bonds
Option to Convert to Equity: Convertible bonds give bondholders the option to convert their bonds into a predetermined number of equity shares of the issuing company.
Potential for Capital Gains: Investors may benefit from potential capital gains if the company's stock price rises, as they can convert their bonds into equity at a predetermined conversion ratio.
Perpetual Bonds
No Maturity Date: Perpetual bonds have no fixed maturity date, and the issuer pays interest indefinitely. However, the issuer usually has the option to redeem the bonds after a specified period.
Higher Yield: Due to the absence of a maturity date, perpetual bonds often offer higher yields compared to bonds with fixed maturities.
Fixed Rate Bonds
Fixed Interest Payments: In fixed-rate bonds, the interest rate is predetermined and remains constant throughout the bond's tenure. Investors receive regular fixed-interest payments.
Stable Income Stream: Fixed-rate bonds provide a stable and predictable income stream for investors.
Floating Rate Bonds
Variable Interest Payments: The interest rate on floating-rate bonds is not fixed but is linked to a benchmark interest rate, often adjusted periodically.
Protection Against Interest Rate Changes: Floating-rate bonds can provide investors with some protection against interest rate fluctuations.
Zero-Coupon Bonds
No Periodic Interest Payments: Zero coupon bonds do not make periodic interest payments. Instead, they are issued at a discount to their face value, and the investor receives the face value at maturity.
Capital Appreciation: Zero coupon bonds generate returns through capital appreciation, as they are typically purchased at a discount and mature at their face value.
The Benefits of Investing in Corporate Bonds
1. Steady Income Stream
One of the major advantage of investing in corporate bonds is that it offers investors a steady and predictable income stream through regular interest payments. These payments are called coupon payments. The coupon rate, predetermined at the time of issuance, determines the amount of interest paid to investors, typically semi-annually or annually. This fixed-income nature provides investors with a reliable source of passive income, offering stability and predictability in cash flow throughout the bond's tenure. The benefit for investors lies in the assurance of a regular income stream, making corporate bonds an attractive option, particularly for those seeking consistent returns and a source of income to supplement their overall investment portfolio. Additionally, this steady income feature also acts as a safety net and helps in diversification when financial markets are experiencing volatility.
2. Diversification of Investment Portfolio:
Diversification is a key principle in investment strategy, and corporate bonds offer an excellent avenue for retail investors to diversify their portfolios. By including bonds alongside equities, investors can spread their risk across different asset classes.
For eg: Ramesh, a 40-year-old IT professional working in a reputable IT firm in Bangalore have put a major amount of his savings solely in equities, primarily stocks of various companies. Now, due to the sudden onset of COVID-19, the uncertainty of the world economy led to significant volatility in the market which resulted in his portfolio taking a big fall. This is the case because he has only invested in a high-risk high-reward investment vehicle. Had he allocated a portion of his savings in the Corporate bond market along with equities, his portfolio would have managed the market volatility in a better way as corporate bonds offer a steady income stream through regular coupon payments and provide a fixed maturity date when the principal will be returned. By adding these bonds to their portfolio alongside equities, Ramesh achieves a more balanced allocation of assets
3. Attractive Yields in a Low-Interest-Rate Environment
In the current economic climate where interest rates are relatively low or steady, corporate bonds offer an attractive yield compared to traditional savings accounts or fixed deposits. Retail investors can capitalize on the higher coupon rates offered by corporate bonds to potentially achieve better returns on their investments, making it an appealing option for those looking to enhance their overall portfolio performance.
4. Increasing Retail Participation in the Bond Market
The Indian bond market has witnessed a notable surge in retail participation in recent years. This can be attributed to various factors, including increased awareness, simplified investment platforms, and the desire for a more balanced investment approach. SEBI have also played a role in fostering retail participation by introducing investor-friendly measures and promoting education about bond investments.
5. Maturity Dates Allowing to Achieve Specific Financial GoalsCorporate bonds have specific maturity dates, allowing investors to align their investments with their financial goals and needs. This feature enables better financial planning and management.
6. Credit Ratings
Another major benefit of corporate bonds is that they are rated by credit rating agencies which helps investors in providing insight into the creditworthiness of the issuing company. This information helps investors assess the risks associated with investing in specific bonds
7. Higher Returns than Government Bonds
Corporate bonds typically offer better returns than government bonds, making them an attractive option for investors seeking higher yields. Corporate bonds are considered riskier than government bonds, but with higher risk comes the potential for higher returns. This is where credit ratings come to play. Companies with higher credit ratings have a lower chance of defaulting, reducing the risk associated with corporate bonds. While government bonds are considered safer due to the backing of the government they generally offer lower yields compared to corporate bonds. Ultimately, the choice between corporate and government bonds depends on individual investors' needs, risk tolerance, and investment goals.
Also Read: Simplifying Taxation on Corporate Bonds
Comparison of Corporate Bonds with Other Types of Bonds for Individual Investors
When considering investment options, individual investors often weigh the benefits of corporate bonds against other types of bonds to make informed decisions. Here is a comparison based on information from various sources:
Corporate Bonds vs. Government Bonds
Advantages: Corporate bonds generally offer better returns than government bonds, providing a steady income stream for investors.
Disadvantages : Corporate bonds may carry higher risks compared to government bonds due to credit risk and potential default by the issuing company
Corporate Bonds vs. Municipal Bonds
Advantages : Corporate bonds are often seen as less risky and less volatile than stocks, offering a reliable stream of income for investors
Disadvantages: Corporate bonds may have lower returns compared to stocks, and investors need to assess credit risk associated with corporate issuers
Corporate Bonds vs. Bond Funds
Advantages: Individual corporate bonds provide pricing transparency and can offer higher potential investment returns compared to bond funds
Disadvantages: While corporate bonds offer the security of income and principal, they may involve credit risk if the issuer defaults, leading to potential loss for investors
Corporate Bonds vs. Other Asset Classes
Advantages: Individual corporate bonds are considered less risky than stocks and can provide a balance of risk and return for investors
Disadvantages: Credit risk is a key disadvantage of corporate bonds, as investors face the risk of not receiving interest payments or principal if the issuer defaults.
In conclusion, investing in corporate bonds can offer individual investors a balance of risk and return, providing steady income, diversification benefits, and lower volatility compared to stocks. Understanding the advantages of corporate bonds and conducting thorough research can empower investors to make informed decisions aligned with their financial objectives and risk tolerance.