In India, various financial markets viz; equity, derivatives, commodity, currency etc are relatively well developed compared to corporate bonds markets. But this market seems to be catching investor interest of late, especially when equity markets have become very volatile.
Bonds are considered to be safe haven for investments, compared to equities. This is because, unlike in equities, returns from bonds are assumed to be fixed. Bonds also help in risk diversification and thus the investors who have low risk appetite opt for bonds instead of equities and mutual funds. But often investors fail to differentiate the risk profile of types of bonds viz corporate bonds and Government bonds (G-Secs). Unlike government bonds, corporate bonds are very much subject to the risk profile of the entity issuing the paper. This means subscribers to the bond issue of corporate sporting bad fundamentals are subject to nearly as much risk as its shareholders.
Nevertheless, return hungry investors these days are focused on the yield and tenure of corporate bonds. Hence the lure of higher returns is leading them to compromise of the safety of the principal.
An article on firstpost, has discussed about a classic example of Manappuram Finance's NCDs (Non-convertible debentures). As per this article, the price of its NCD has declined on back of concerns over its credit rating in the bond market. This has hit the bond holders of the company who have invested at higher levels and thus eroding their capital holding. Most of the rating agencies have given the company A- rating indicating that the company's financials could deteriorate further. These risks, also bring down the liquidity of the bonds.
The reason why Manappuram business got a hit was its nature of business. The company had witnessed robust growth of 112% CAGR in past four years. However, when gold prices kept hitting lower levels, the company's business got impacted and has resulted to various write offs.
It is evident from the above example; that an adverse impact on the business of the corporate could have an impact on its credit rating and thereby impact the prices and liquidity of its bonds. In an extreme case, there is fair probability of debt default too.
Meanwhile, Mahindra and Mahindra (M&M) has issued plain vanilla bond with maturity of 50-years. The credit rating agencies have given superior ratings to this bond. Thus in order to retain its rating throughout the unusually long tenure, the company will have to ensure that it consistently grows sales and profits and launches new products.
Thus, the investors should not get carried away by the attractive returns and longer tenure of these bonds. Investors should note that corporate bonds carry an additional risk of default unlike G-Secs. Though, the risk may vary for different companies. At times the corporate issuers tend to offer higher yield in order to compensate for the higher risk, but not commensurate enough.
Thus investors should assess the risks of bonds very carefully before investing in them. Comparing the risks of various bonds, nature of business of the corporate, historical rating, risk free interest rates, liquidity, etc are some of the aspects where investors should look at before making an investment.