Infrastructure bonds for the risk-averse

Written by Adhil Shetty | Updated: Dec 7 2012, 16:03pm hrs
The government has major plans for infrastructure development in the 12th Five Year Plan. The need for infrastructure is pegged at $1 trillion. Keeping in view the massive need of funds, many firms in India have launched infrastructure bonds. Lets look at one such example. Rural Electrification (REC) is one of the most well-known companies to issue an infrastructure bond. On December 3, it launched the REC Tax-Free Secured Redeemable Non-Convertible Bonds.

At a glance

The issue opened on December 3 and closes on December 10. The use size for retail investors is 40% of the total issue, which means about R4,500 crore. The bond is available in both demat and physical form. Hence, people without an online account can invest in it too.

REC is one of the Navratna companies and, hence, investing in this bond is a very low-risk investment. It is also supported by the rating provided by rating agencies such as Crisil, Care and Icra. Moreover, a large part of the company is held by the government, making it almost risk-free investment.

Should you invest

The answer depends on what you want from this investment. Lets look at some of its features.

Safety: The investment is absolutely safe. The company is financially sound, highly rated by rating agencies, and owned by the government. This makes the risk of default almost nil. A high rating of AAA shows the company is financially sound to fulfill its obligation to bondholders.

Returns: The returns are in the range of 7.72-7.88%. This is not great as such, but when you consider the non-existent risk, it is quite good. This is even more valid when you see that the returns on other safer options have reduced.

Tax-saving feature: The returns earned by investing in REC bond are tax free. When you consider 7.72-7.88% returns with tax savings, the investment looks very attractive. Investors are eligible for tax deduction under Section 80CCF of the Income tax Act. This means investors can save R6,180 if they fall in the highest tax bracket 30.90%; R4,120 if they are in the tax bracket of 20.60%; and R2,060 if they fall in the tax bracket of 10.30%.

Capital gain potential: Typically, when the interest rates go down, bond prices go up. Interest rates seem to have peaked in India. There is a very high possibility that the rates will start moving down from here. When this happens, investors will also gain in terms of bond prices going up.

Benefits of investing in bonds

Bonds offer two major advantages over equity or mutual fund investments.

Regular income: Bonds offer regular income in the form of coupon. REC offers 7.72-7.88% coupon payment every year. Hence, investors who need regular income can go for bonds investment.

Lower risk: Bonds are low-risk investments. Even when some bonds offer high risk, investors can evaluate the risks by looking at the rating assigned to the bond. Rating helps investors set the right expectation. Usually, a low rated bond will offer higher returns to compensate for the risk. The best part of bond investment is that all the bonds have to go through a rating process.

Last but not the least, bonds are relatively less risky from the payment perspective.

However, they have their own risk. There is the risk of inflation and interest rate. For example, an inflation of 9% when the coupon rate is 8% means that your real returns are negative. At the same time, when the interest rate goes up, the value of your investment in bonds will go down as they are inversely proportional.