Of late, PSBs are facing several problems. They are finding it difficult to maintain their asset quality. The constraints on government to recapitalise them optimally is chocking the capital flow in the system. Government borrowing program puts an additional burden on the Indian banking system.

[Read This If You Hold Deposits With Public Sector Banks]

Going by the experience of PSBs and private sector corporate banks, other banks are also reluctant to offer loans to corporates fearing the possibility of assets turning into non-performing someday.

On this backdrop, having a thriving bond market to enable corporates to raise money quickly and economically is extremely important.   

Unfortunately, the Indian bond market isn’t as deep as the equity markets. But the Regulators and governments have made a cautious effort from time to time to make the Indian debt market more vibrant and investor-friendly.

It seems the Securities and Exchange Board of India (SEBI) is planning to take one more step in this direction.  

As reported by The Economic Times dated August 27, 2018, the capital market regulator is pondering on allowing corporations to offer on-tap bonds directly to investors, including the retail investors.

What difference will on-tap make?

• It will allow companies to collect money multiple times during a financial year. Thus, on-tap issuances will offer them more flexibility.

• ‘On-tap’ issuances will be extremely economical since there will be no need to file a prospectus with the regulator multiple times. There would be subsequent savings in other costs related to bond issuances.

Global experience…

On-tap bond issuance is a popular method globally, especially in the European markets such as the United Kingdom (UK) and France. Usually, this method is deployed to raise money for the short-to-medium term maturities. The nature of ‘on-tap’ allows the issuer to issue bonds at a prevailing market value without changing other terms such as face value, the rate of interest, and maturity of the security, among others.

In other words, such issuances help harmonise the demand and supply situation. If the Companies issue bonds in a single tranche, they might face several hurdles including unfavourable market conditions. Moreover, regulatory constraints such as upper limit for Foreign Portfolio Investors (FPIs) on exposure to corporate bonds may also affect the response to auctioning of bonds. They might even end up raising more capital than they require immediately, to save cost and additional paperwork.

Issuing bonds ‘on-tap’, on the other hand, may allow corporates to raise money as and when they need it and (or) when there’s a demand for such issuances.  

Should you invest in bonds offered ‘on-tap’?

(Image source: thebluediamondgallery.com)

Investing in bonds directly isn’t as simple as it may sound. Please don’t forget, bonds have a credit risk. Plus, they also expose you to interest rate and reinvestment risk. So, Investing in bonds isn’t risk-free.

[Read: Why Debt Funds Aren't Safe And Can't Guarantee Fixed Returns] 

Credit risk, also known as default risk is the risk of losing capital. Interest rate risk is a coupon or interest payment turning unattractive due to potentially higher rates offered by newly floated comparable credit instruments. When interest rates go up, prices of existing bonds fall and vice-a-versa. Reinvestment risk means you won’t find attractive investment opportunities to invest income generated through interest receipts.

Therefore, unless you understand debt markets really well, you should avoid investing in bonds, including on-tap bonds directly.

Are mutual funds a better option?

Yes! Certainly, they are.

Instead of investing in bonds directly, you can invest in debt funds which eventually invest in bonds.

But taking this chance is high risk too.

Even mutual fund houses have committed grave mistakes in picking debt securities several times.

PersonalFN believes, before you invest in any debt fund, you should be absolutely sure of your time-horizon. If not, you could incur heavy losses in debt funds.

For example, if your time horizon is just six months and you invest in a long-term income fund, you are likely to earn miserable returns if interest rates go up or credit risk goes up.

Conversely, if you have a time horizon of three years and yet you invest in an ultra-short-term bond fund, you might generate low returns as compared to what you could have easily made in a medium-term income fund.

Like in the case of any other investment, you should follow your personalised asset allocation which considers your financial goals, current financial situation and risk appetite before investing in a debt fund.

Watch this video:

How to select a debt fund…

You should invest in a debt fund offered by a fund house which adheres to sound investment systems and processes. Ideally, you should invest in a debt fund which has an impeccable track record of maintaining high credit quality across time frames and plays the interest rate cycle well.

[Read: 5 Facets To Look Into While Investing In Debt Mutual Funds] 

Systematic Investment Plan (SIP) isn’t a good option to invest in debt funds.

Happy Investing!

Author: PersonalFN Content & Research Team

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