Is this investment worth putting money into?

May 14, 2013

In this issue:
» Fiscal year begins on a poor note for auto companies
» Risks of China's shadow banking system
» Margin debt on US stocks has risen
» Is the 30 year bull market in bonds over?
» ...and more!

In an environment where the economy has slowed down and inflation has remained high, investors are scrambling for investments yielding good returns. One such investment avenue which has generated some interest in recent times has been corporate fixed deposits (FDs). These are deposits just like with banks, but they offer interest rates (for instance those with AAA rating) which on an average are 1-2% higher than bank deposits.

Because they provide better rates than bank FDs, the former are probably finding more takers as inflation eats into interest on bank FDs. But that does not mean that corporate FDs are always safe. Quite the opposite. While the rates promised are high, the risk factors with respect to these FDs are also high. One of them is that these deposits are unsecured. So if the company is unable to repay, the principal is entirely lost.

Hence, when evaluating corporate FDs, it becomes very important for investors to study the fundamentals of the company, whether it is in a sound financial shape and will be able to honour its commitments. A company which has been consistently in the red will obviously be a very risky bet even if it promises high returns. Of course, credit rating agencies also provide ratings on the same. But it still becomes important for investors to do their own homework before they make any decision.

At the end of the day, no investment in any asset should be made because it has become a fad. Investors need to understand their financial goals and risk appetite and make their investments accordingly. So while we do not intend to write off corporate FDs entirely, we believe that investing into them solely on the basis of better returns promised would not be the right way of doing things.

Also, while it is a good idea to keep away some safe cash in the form of fixed deposits etc, please make sure that you do not lose sight of your overall asset allocation.

Do you think investing in corporate FDs is more risky than bank deposits? Please share your comments or post them on our Facebook page / Google+ page

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 Chart of the day
It has been a well documented fact about how poor FY13 was for the Indian auto industry. As the economic slowdown and firm interest rates took their toll, demand dampened and volume growth was severely hit. Little wonder then the auto industry was relieved to put FY13 behind them. But has the start to the new fiscal been different? Not really. As can be seen from the chart, volume growth in the first month of FY14 has been very poor for most segments in the auto space. Even utility vehicles, which were the star performers in FY13, failed to take off during the month. Most of the companies expect the first half of this fiscal to be challenging as well, but believe things to start picking up thereafter.

*Passenger vehicles, **Commercial vehicles
Data Source: SIAM

The Credit Guarantee scheme has been a very popular form of shadow banking in China. How it works is that company A acts as a guarantor of company B's loans. In turn, some subsidiary of company B acts as a guarantor for company A. If either of the company went bust, banks would end up calling loans for every company in the chain. Since these companies too might have guaranteed loans for others, more companies get into trouble. This therefore ends up becoming a viscous cycle of loan defaults. As per Moneynews, rating agency Moody's has cited a warning signal on China's thriving shadow banking system which poses systemic risks. The nation's financial industry has expanded by more than 67% over the past two years. But the same has been on the back of many compromises on asset quality. While the rating agency has just pointed at the tip of the iceberg, we will not be surprised if a full-fledged financial crisis shows up in due time.

Buying anything using debt is risky. So if the debt being used to buy a particular asset is increasing, then it could be an indicator for trouble. This is what seems to be happening with the US stocks. As per an article carried by Money news, the margin debt on the stocks has gone up by 18% from a year earlier. This has led to a rise in stock prices leading some to worry that there could be a bubble forming in the stock prices. For if there is a correction in stock prices, the losses would get more pronounced due to the margin debt. This is because a small fall in the stock prices would force margin borrowers to sell off all their holdings. As a result the decline would become cascading in nature and hence more pronounced. The reason why margin debt is going up can be traced back to the QE program of US. Cheap money and near zero interest rates make taking debt attractive. Since the companies and government are all wary about making investments, most of this money is flowing into the capital markets. And this is creating asset bubbles. Whenever the bubbles burst, the consequences will be disastrous.

What's going on in the global bond market? This question seems hardly relevant to stock market investors. What do bonds have to do with stock prices? Well, at the surface there seems to be no direct relation. But in reality, all asset classes are quite interrelated. And as such, any major development in a certain asset class does tend to impact other assets as well.

As a thumb rule, bond market and stock markets move in opposite directions. This is because stocks tend to perform well when the economy is growing. Investors turn to bonds when they perceive significant risk in the economy.

But how is it then that both stock and bond markets are moving up in the US? The answer is a flood of cheap money injected by the central bank. Recently, bond king Bill Gross has said that the 30-year bull market in bonds has probably reached its peak. Taking into account that bond and stock markets have been moving in tandem, have US stock markets also reached their zenith?

If the US stocks crash, it will have far reaching repercussions on markets across the globe. India included.

The Economic Times has reported that the Ministry of Power is seeking advice of regulator Central Electricity Regulatory Commission. This is towards tackling fuel availability for certain projects. It is believed that existing power capacities of 37,680 MW and upcoming capacities of 28,000 MW could benefit from the outcome. One outcome being discussed is a provision for passing on the additional costs to customers.

A few years ago, through the process of competitive bidding, power producers signed power purchase agreements. These were done keeping certain factors in mind. The factors included assurance in terms of coal supplies; largely to be made by Coal India (CIL). However, CIL has been unable to meet its obligations. This has led power producers to resort to importing coal. Such coal is costlier by about 40% as compared to domestic coal. With fuel prices moving up, it's the power producers who have been impacted as their project viability has come under question. Passing on costs is a difficult and lengthy process and one that the government does not prefer considering that the eventual impact would be on the final consumers.

On an overall basis, it does indicate the sticky situation the government is in. While on one hand, there are concerns relating to power shortage and possibly systemic failures. But without appropriate pricing, power produces may not want not add capacities. Either way, it does seem that the consumers who be bearing the cost burden.

The Indian equity markets moved about in a volatile manner today, with the BSE-Sensex alternating between the green and red zone through most part of the day. At the time of writing the BSE-Sensex was trading higher by about 60 points or 0.3%. Barring stocks from the FMCG and consumer durables spaces, interest was seen in stocks across the board with those from the oil and gas and healthcare spaces witnessing maximum interest. The BSE-Midcap and BSE-Smallcap indices were up by about 0.2% and 0.1% respectively. Stock markets in rest of Asia ended the day on a weak note with Japan, Hong Kong and China down by 0.2%, 0.3% and 1.1% respectively.

 Today's investing mantra
"At age 19, I read a book [The Intelligent Investor] and what I'm doing today, at age 76, is running things through the same thought process I learned from the book I read at 19." - Warren Buffett

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    5 Responses to "Is this investment worth putting money into?"


    May 16, 2013



    parimal shah

    May 15, 2013

    These r definitely more risky. And capital may not be always safe. The rating agency gets fees paid by the company. The same rating agency may down-grade the FD after some time. In case of bank FD such is not the case (unless it is some co-operative bank hands-in-glove with people like Harshad mehta or ketan parekh).



    May 14, 2013

    it is safe to invest in bank fdr but for higher returns one can invest on coparate with good rating


    Suresh Raman

    May 14, 2013

    There are certainly corporates which are good in terms of their financial performance and core business strength compared to some of the Banks and hence investing in their FDs is = investing in Bank FDs.


    Sadanand Patwardhan

    May 14, 2013

    **One of them is that these deposits are unsecured. So if the company is unable to repay, the principal is entirely lost.
    Principal lost entirely may come to pass, but the statement is legally incorrect. Unsecured liabilities, such as corporate deposits, will have to join tail end of the creditor's queue for recovery. If assets run out faster than when even the turn of lowly ranked secured creditors comes, then such secured creditors too get nothing.

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