Emerging Opportunities in Debt Investing to Change Investor Profile

Smart-Investments

We need a balanced diet for healthy living. Similarly, a balanced investment portfolio is essential for healthy finance.

In India, people invest 65 per cent of their savings in physical assets like gold and real estate. Only 35 per cent is invested in financial assets. In financial assets, the preferred choices are bank FDs, PPF, post office savings schemes and insurance. Investing in debt instruments is not popular. The reason is that debt investing is not well developed in India. This is going to change.

Presently, investors have two primary modes of debt investing: one, investing in debt schemes of mutual funds (MFs) and two, investing in Non-Convertible Debentures (NCDs) of companies. There is also a third option of investing in Government Securities (G-Secs). But retail participation in G-Secs is limited. Debt schemes of MFs and NCDs have many attractive features for a wide spectrum of investors. For instance, investment for 36 months or more in debt schemes of mutual funds is taxed only 20 per cent with indexation benefits. When indexation is availed, the real tax incidence will be very low. The average annual post-tax returns from the best performing MIPs during the past six years have been more than 9 per cent. For investors in the high tax bracket of 30 per cent, this is highly attractive. Also, since debt funds are highly liquid, the investment can be converted into cash at short notice. Most investors are not aware of these benefits.

NCDs offer steady returns at a fixed rate, but there is some risk. When it comes to investing in NCDs it is important to note that not a single NCD with AAA rating has failed. But for NCDs without such high rating, there have been a number of defaults. With regard to returns from NCDs, typically low credit rated NCDs offer higher returns.

The corporate bond/debenture market in India is on the cusp of a takeoff. In developed countries corporates raise debt from the bond market for their funding requirements. In most emerging markets, bond markets are not developed. In India the market for corporate bonds is illiquid and therefore, retail investors do not participate. 95 per cent of bond/debenture issues are privately placed. The recent bond market reforms announced by the RBI will have far-reaching beneficial consequences. RBI will allow corporate bonds in REPO transactions and will push corporates to borrow from the market. The idea is to develop the corporate bond market by increasing the demand and supply of bonds.

In an environment where interest rates on Fixed Deposits are falling, debt investment can be ideal. Interest rates and bond prices move in the opposite direction.

Therefore, when interest rates are trending down, as is the case presently, bond prices go up and investors in bonds reap capital gains. Hence, debt funds can offer higher returns than FDs. Retail investor participation in debt funds is going to explode, going forward.

(The author is Investment Strategist, Geojit BNP Paribas)