With benefits like fixed returns and lower volatility, bonds can be a potential option to diversify your portfolio. Read on to learn more about how to invest in corporate bonds in India, starting with the basics.
What are Corporate Bonds in India?
Corporate bonds are debt securities issued by private organizations to raise capital for goals like machinery purchases, business expansion, and more.
Like other types of bonds, corporate bonds also offer fixed returns to investors in the form of interest repaid along with principal at fixed intervals. That’s why they are classified as fixed income securities.
The following points are crucial and can help you understand what is corporate bond in India:
- Corporate bonds generally have a validity of over one year and are categorized as medium to long-term debt instruments.
- Any corporate debt instrument with a validity of less than one year is known as a ‘commercial paper’.
- Corporate bonds offer higher returns than government bonds but also carry a higher risk as well.
- The coupon rate of corporate bonds is determined based on the ratings given by authorized credit rating agencies.
- Corporate bonds with a credit rating between AAA to BBB are called investment-grade bonds. All other corporate bonds are known as non-investment grade bonds (explained below).
- Based on the issuer, corporate bonds enjoy medium to high liquidity in the secondary market.
Non-Investment Grade bonds: Low-quality, low-rating bonds that are speculative and generally avoided. Another popular term for this is “junk bonds”.
How to Assess Credit Ratings of Corporate Bonds
India has several credit-rating agencies like CRISIL and ICRA that evaluate the creditworthiness of companies that issue corporate bonds. This is in turn the credit rating of the bond.
That’s why you as an investor must get to grips with the methodology and criteria used by the likes of CRISIL. Each agency uses different criteria but it broadly includes:
- Issuer’s financial performance
- Debt repayment record
- Industry outlook
For example, let’s consider a corporate bond issued by Corp B. The organization manufactures agricultural products like fertilizers. CRISIL rates this bond as “AA+”.
A high rating like that indicates safety, timely payment of interest, and a solid likelihood of getting your principal back.
On the other hand, ICRA assigns a rating of “A+” for the same bond, which means a decent (not solid) chance of getting your principal back along with the returns.
What do you make of these conflicting ratings? Both bonds are rated A or beyond, meaning the bond can be a lucrative investment.
But once you delve into the rating methodology, you’ll understand the nuances. To do so, you can analyze the financial statements of the issuing company. Check factors like:
- Revenue growth
- Debt-to-equity ratio
Either way, you must pay special attention to diversification not just across corporate bonds but also credit ratings.
Lastly, you should monitor changes in credit ratings and stay updated on market developments, as any shifts in ratings can signal changes in the issuer’s financial health.
Pros of Investing in Corporate Bonds
Now that you know, what is corporate bonds in India and the rating mechanism, let’s have a look at the pros of corporate bonds to help you make an informed investment decision:
1. Low Volatility
Compared to equity investments, corporate bonds are less exposed to market volatility. They are considered a safe investment option for capital preservation during economic uncertainties.
2. Regular Income
Corporate bonds are preferred by investors seeking steady returns from their investments.
As per the applicable terms and conditions, you receive regular interest payments at given intervals to support your income.
P.S. If you like regular income, you’ll like the best sources of passive income in India.
3. Risk Management
Corporate bonds with ratings of AA+ or above are considered relatively safe for investors looking to protect their money from inflationary forces.
These bonds offer higher returns than government bonds. However, rating matters the most here.
Cons of Investing in Corporate Bonds
Much like any other investment, corporate bonds also carry certain limitations that you need to be aware of. We’ve compiled them below.
1. Limited Liquidity
Some corporate bonds suffer from lower liquidity. When bonds have lower trading volumes, it can be a challenge to purchase or sell them at desired price levels.
2. Higher Risk
Corporate bonds present a higher investment risk compared to government bonds. There can be instances where the issuer is unable to make timely payments for the interest or principal.
3. Impact of Inflation
While corporate bonds offer steady returns, the purchasing power of fixed coupon payments reduces over time due to inflation. As a result, the real returns earned can go down.
How to Invest in Corporate Bonds in India?
There are various options available to invest in corporate bonds. Here we’ll have a look at the steps for investing in corporate bonds in India through a registered broker like Dhan:
- Choose a registered broker, like Dhan, which provides the opportunity to invest in corporate bonds.
- Open a trading account to start your investment journey. Complete the Know Your Customer (KYC) process to verify your identity.
- Engage in detailed research to identify the most suitable corporate bond options available. Consider important factors such as the coupon rate, risk levels, credit rating, etc.
- Once your trading account is activated, you can place an order for the chosen corporate bonds.
- Upon successful transaction and settlement, the corporate bonds will be credited to your demat account.
You may also choose to purchase bond mutual funds (debt mutual fund) or Exchange Traded Funds (ETFs) to make an indirect investment in corporate bonds. By the way, here’s a video that compares bonds and mutual funds.
Where to Buy Corporate Bonds in India?
If you are wondering where to buy corporate bonds in India, there are two options available for you. They are:
The primary market, often referred to as the issue market, provides a direct avenue for individuals to apply with the bond issuers.
Within the primary market, you can participate in a Bond IPO (Initial Public Offering).
The bonds will be allocated as per the total number of bids received.
Another option available in the primary market is to apply for bonds through private placement.
In this scenario, the issuer extends an offer to a select group of institutional investors to purchase the bonds.
The secondary market, also known as the after-issue market, serves as a platform where you can acquire bonds from fellow traders and investors.
Unlike the primary market, there is no allocation process involved in this market. Once the settlement is successfully concluded, the bonds are promptly credited to your demat account.
Corporate bonds are a good option for investors seeking diversification and stable returns.
But there are certain risks, related to credit ratings and liquidity, that necessitate careful analysis before reaching a final decision.
Once you understand the steps about how to invest in corporate bonds in India, you can plan your investments better.
To explore the best investment options, you can consider Dhan to trade and invest in Stocks, F&O, Currencies, and Commodities.