Introduction

Are you looking for a fixed-income investment that offers better returns than a bank fixed deposit? The Indian corporate bond market could be the right option for you. In India, corporate bonds are debt securities that companies issue to raise capital. When you invest in corporate bonds, your earnings are the interest (coupon) payment that you will receive regularly, portfolio diversity and having a portfolio of bonds. SEBI regulates corporate bonds, which represent an essential form of company financing and an attractive investment object to investors. Now we will examine what corporate bonds are, how to invest in them, and most importantly, how to invest.

What Are Corporate Bonds?

Corporate Bonds are loans you make to companies and receive regular interest payments (coupons) and the full loan investment ($) returned when the bond matures. For example, if you invested ₹1 lakh in a corporate bond with a 7% annual coupon rate and a maturity of 5 years, you would receive ₹7,000 in interest every year, and at the end of the 5 years, you would receive back your ₹1 lakh. Corporate bonds, which are often used interchangeably with debentures under the Companies Act in India, can be issued by public/private companies or statutory corporations like LIC, but not by foreign corporations incorporated outside of India.

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Why Invest in Corporate Bonds?

Investing in corporate bonds in India has its benefits. First, they usually offer a better interest rate than a bank fixed deposit or a postal savings scheme; therefore, you should enjoy a better return with a corporate bond instead. Secondly, they return you a fixed income at pre-defined monthly, quarterly or annual intervals. The cash flow is predictable and fixed. Corporate bonds also provide liquidity if listed on NSE or BSE, as you may sell them in the secondary market. Lastly, some bonds may provide capital appreciation if they trade above their face value. If the company is liquidated, surplus funds will be distributed to bondholders first, as secured lenders take precedence over unsecured creditors, including shareholders.

Types of Corporate Bonds:

You can choose from a range of corporate bonds depending on your goals and risk profile:

Secured vs. unsecured bonds

Company assets are typically backed by secured bonds, which can give you a higher level of safety if you have risk aversion or a lower risk appetite. However, the trade-off is lower returns. Unsecured bonds carry more risk, but as such, returns are much more lucrative.

Convertible vs. non-convertible bonds

Convertible bonds can be converted into equity, whereas non-convertible bonds cannot. Therefore, convertible bonds will often attract a lower coupon rate and interest while offering the opportunity for capital gains if the company’s equity value rises. Non-convertible bonds remain simply debt instruments with higher coupon rates and interest.

Callable vs. Puttable Bonds

Callable Bonds allow the issuer to redeem them earlier than the maturity date, and sometimes earlier than the call date. Callable bonds carry reinvestment risk and higher yields.
Puttable Bonds allow you to sell or put the bond back to the issuer at specified bond dates. This option would be worth less in your bond purchase price but gives you more flexibility in a pullback market with lower returns.

How to Invest in Corporate Bonds?

Corporate bonds can be purchased in several ways. Public issues allow you to buy bonds directly from the issuer through the prospectus. Private placements serve primarily institutional investors, and access is limited. Buying on the primary market allows you to purchase the bond when offered, and the secondary market allows trading on the NSE/BSE if the bond is listed and has low liquidity (subject to the company's ability to make early payment). When purchasing, always look through the bond offer document, including details such as the type of interest rate (fixed or floating) and frequency of payments, as well as the maturity date.

Factors to Keep in Mind Before Investing

Before you start evaluating, consider the following:

Credit Risk: Consider the ability of the issuer to pay the interest or principal payments. Consider checking the agency ratings, such as (CRISIL, ICRA, etc), where a higher rating (i.e., AAA) indicates low risk of default.

Interest Rate Risk: As market interest rates have the potential for prices to fall, your returns are impacted if the bond is redeemed before the sale date.

Liquidity Risk: Unlisted or less frequently traded bonds may have liquidity issues, increasing yield spreads.

Financial Measures: This may include ratios such as the Interest Coverage Ratio (EBIT/Interest Expenses) to gauge the issuer's ability to pay interest, and the Debt-to-Equity Ratio to gauge some financial stability. Examine the revenue trend and any previous defaults.

Tax Consequences

Income tax slab rates apply to interest from corporate bonds. If you sell listed bonds held for over 12 months, long-term capital gains will be taxed as LTCG at 12.5% without any indexation benefit. Short-term gains and unlisted bonds (post 23rd July 2024) will only be taxed at your slab rate. Interest income attracts TDS of 10% u/s 193.

Conclusion

Corporate bonds in India offer a compelling mix of relatively higher returns, enhanced fixed income, and a further source of diversification. By examining the issuer's financial position, the type of bond, and market conditions, one can find the sweet spot between an investment class and one's financial objectives.

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