Foreign investors are increasingly interested in the Indian corporate debt market as domestic government securities are set to debut on the JPMorgan Emerging Market local currency debt index on June 28, expected to bring in $20-25bn in passive inflows. Recent data indicates higher purchases in corporate bonds and ETFs, along with a strong demand for dollar bonds. Despite the current investments remaining tepid, investors can anticipate an uptick as more foreign investors engage with Indian debt instruments, which have traditionally been overlooked in favor of government bonds.

With the increased interest from global fixed income investors, market participants hope the inclusion in the global bond index will boost liquidity and drive further interest in Indian corporate debt. Some foreign fund managers are even considering launching ETFs focused on this sector. Additionally, investors have shown interest in dollar bonds of Indian companies, with companies paying lower interest on these bonds than their initial guidance.

The Indian bond market has reached a remarkable value of ₹205.3 lakh crore (approximately $2.5 trillion) as of September 2023. Government bonds dominate, holding 78% of the market due to their low-risk nature and high investor trust. Corporate bonds account for 22%, reflecting private enterprises’ participation in capital raising. The bond market has grown 77% in the past five years, driven by factors like economic expansion, policy reforms, infrastructure investment, and increased investor awareness. These elements have boosted investor confidence and demand for fixed-income securities, contributing to the market’s robust growth.

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Understanding Corporate Bonds

Corporate bonds are debt instruments issued by corporations with a maturity of over one year. Unlike stocks, investing in corporate bonds does not grant equity in the company. Instead, the company pays interest on the principal, which is the investor’s profit. Regardless of the company’s financial performance, it is obliged to pay bondholders interest and the principal amount.

Types of Corporate Bonds

Fixed Rate Bonds: These have a fixed coupon rate paid to bondholders until maturity.

Zero Coupon Bonds: Issued at a discount, these bonds do not pay regular interest. The profit is the difference between the bond’s final value at maturity and its discounted purchase price.

Tax-Free Bonds: Interest from these bonds is tax-free and issued by public sector undertakings for various projects.

Convertible Bonds: These can be converted into equity shares at maturity, with the bondholder becoming a shareholder, relieving the issuer from future interest payments.

Who Should Invest in Corporate Bonds?

Market Exposure Seekers: Investors looking for market exposure with stability and income may find corporate bonds appealing.

Fixed-Income Alternatives: Investors seeking higher interest rates than government bonds but lower risk than equities should consider corporate bonds.

Financial Stability Assessors: Investors looking for stable income from fixed coupon rate.

Portfolio Diversifiers: Investors aiming to diversify their portfolios can benefit from including corporate bonds.

Features and Benefits of Corporate Bonds

High Returns: Corporate bonds generally offer higher returns compared to government bonds or bank FDs.

Risk Optimisation: Investing opportunities are available across the credit spectrum from investment grade credit-rated bonds (AAA, AA, A or BBB) to unrated or below investment grade rated bonds providing higher returns.

Liquidity: Availability of option to buy o sell from the secondary market allowing bondholders to respond to market price fluctuations.

Short Tenure: Corporate bonds have a shorter tenure (60-120 months) compared to government securities.

High Coupon Rates: Corporate bonds offer higher coupon rates (7-12%) compared to government securities (around 7%).

Risk Factors and Returns

Corporate bonds provide diversification and steady income but come with risks such as credit risk, market risk, and interest rate risk. Investing in bonds with high credit ratings (AAA or AA) is advisable to minimize risk. Bonds with poor credit ratings, known as junk bonds, carries high risk and should be done only where deep research is undertaken. Interest rates are inversely proportional to bond market value and volatility increase with duration, and past performance does not guarantee future interest rate trends.

How to Invest in Bonds in India

Investors can buy bonds through various channels, including banks, individual distributors, online platforms, and indirectly through mutual funds for a diversified pool of bonds. Researching different bond types and associated risks is essential before investing.

Conclusion

Corporate bonds offer many benefits, including the potential for higher returns, low to moderate risk with liquidity and option to diversify. However, understanding the associated risks is crucial before investing. Corporate bonds are ideal for investors seeking to diversify their portfolios with low-risk investments. Ensure to check credit ratings and select the best-rated bonds for optimal returns and minimal risk.

Foreign investors are increasingly looking at Indian corporate debt market, driven by the anticipated inclusion of domestic government securities in the JPMorgan Emerging Market local currency debt index. This development is expected to bring substantial passive inflows, further boosting the attractiveness of corporate bonds. As market dynamics evolve, corporate bonds stand out as a viable option for investors seeking stable returns and portfolio diversification. With the right research and understanding of risks, corporate bonds can be a valuable addition to an investment strategy, offering a balanced approach to achieving financial goals.

(By Vivek Goel, Co-founder and Joint Managing Director at Tailwind Financial Services)

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