If
you have just begun your investment journey, you may have heard of asset
allocation and diversification of portfolios. One of the ways to diversify your
investment portfolio is to include corporate bonds.
A
corporate bond is a debt instrument issued by
a company so as to raise capital. Thus, a company can get the capital it
requires and the investor gets payments at either variable or fixed interest
rates which is also called as coupon rate. These interest payments are often
pre-set. This way, the investor gains a steady source of income as well. When
the bond reaches expiration, the interest payments stop and the original
investment is given back to the investor. The investor becomes the lender and
the company becomes the borrower in a corporate bond investment scenario.
It
is only in recent times that India is seeing an interest in the corporate bond
market. Owing to the pandemic and the low yield due to the stimulus that was
induced, there has been an interest among companies to issue bonds in India.
(Image
source: Livemint*)
So, how different are corporate bonds from stocks?
Although
corporate bonds and stocks are both about investment in the capital markets,
bonds are different from stocks. The latter are instruments of equity wherein
the investor has a stake in the company’s ownership. Both stocks and bonds are
raised by organisations that need to raise capital. However, bonds can be
issued by governments, non-profits, corporations and any kind of entity. On the
other hand, stocks can be issued by corporations, partnerships or sole
proprietors of a company. While stocks can have a greater element of
volatility, bonds are fixed-income investments which are not as volatile.
If
you are interested in the bond market, you can invest in two modes: by opting
for mutual funds that invest in bonds or by buying corporate bonds. If you are
opting for corporate bonds you may look at buying in the primary issue or in
the secondary market. In the secondary market, there could be a problem of
absence of liquidity, which means you may not always get the bond you prefer.
In the primary issuance, there are bonds to suit any kind of wallet. The bonds
in primary issuance come with different maturity dates and you can choose the
one that is apt for you.
In
the secondary market, you would need to buy bonds through a third party, ie, a
broker. If you open a demat account, you can directly purchase bonds and don’t
have to go through a broker.
Points to consider while investing in corporate bonds
• Yield:
This is one of the most important aspects while talking about corporate bond investments. It is the element you can use to compare a bond with another and decide which one to buy. But it is not a fixed measure because of changing interest rates. Therefore, there are two ways to measure yield: current and yield to maturity. The current yield is the yearly return on the amount you paid to buy a bond, irrespective of the maturity. The yield to maturity is the overall returns you will get if you were to hold that bond till it matures.
• Coupon:
When you buy bonds, the company makes interest payouts till the bond matures. This interest that the company gives is called the coupon.
• Value:
The value of corporate bonds increases when interest rates dip and vice-versa. The longer the time to maturity, the greater the volatility in price.
• Credit ratings:
The credit-worthiness of bonds matters a great deal while buying them. The ratings help investors assess the corporation or company’s ability to repay debt. Ratings also help investors assess the credibility of the company that has issued the bond. These ratings are issued by agencies like CRISIL, CARE or ICRA.
• Research:
Although credit agencies issue ratings, it is important to do your research on the companies that are offering bonds when you plan to buy corporate bonds per se rather than via mutual funds or exchange-traded funds that are corporate-bond oriented. Make sure you don’t buy a corporate bond that may be at risk of a default.
Types of corporate bonds
• Convertible bonds:
If you invest in convertible bonds, you get security alongside interest payments. These bonds could also be converted into shares of the company.
• Zero coupon bonds:
Investing in this kind of bonds means there is no coupon payment but such bonds offer a high discount rate trade.
• Strip bonds:
This is a type of bond wherein the interest and principal components are stripped and sold separately. Once the bond matures, the investor who has invested in the principal receives the amount equal to the face value of the bond while the investor who has bought coupons receives the coupon payment.
• Junk bonds:
These bonds come with high interest rates but also a greater risk. They are typically not rated high.
Buying
corporate bonds comes with its own advantages. Bonds offer a steady income
source and offer diversification to your investment portfolio. They also offer
good yields at low risk and are flexible. You could pick corporate bonds on the
basis of your investment horizon, goals and risk profile. Look up Tata
Capital’s Wealth Management Solutions for protecting and growing
your wealth with opportunities to invest in primary or secondary bonds.
09 October 2020
5 mins read
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