Volatility in capital markets has led to a notable shift in investor focus towards fixed income, especially for those seeking stability and wealth preservation. But, even as bonds are considered to be a ‘low-risk’ asset class, it is important to bear in mind that an investment in bonds comes without some inherent risks that the average investor must understand.
The third episode of Mint’s Bond Street Dialogues, powered by IndiaBonds, shifted focus from the basics of and their benefits to a crucial discussion on the potential risks. Vishal Goenka, co-founder of IndiaBonds, spoke to Shayan Ghosh, Editor – BFSI, Mint about the essential safety checks and risks investors must undertake before investing into bonds. He felt that while bonds offer returns superior to traditional fixed deposits, they require investor diligence and strategic to manage volatility and avoid the riskiest segments of the market. His insights provided a practical guide for the modern Indian investor to approach the bond market with necessary caution and knowledge.
Watch the full episode below,
Ensuring platform and product safety
Goenka began by stressing the importance of regulatory oversight, which should be the first crucial check for any investor. “When investing in a bond on a platform, make sure it is a regulated platform,” he said, emphasising that the Securities and Exchange Board of India (SEBI) has established a framework and investors should always verify a platform’s registration.
Beyond the platform, the type of bond purchased is also important. He strongly advised investors to buy only listed bonds. “The first smell check is the platform semi-regulated, are you buying listed bonds? Because if something were to go wrong, you will get added coverage on that,” he said.
Listing provides an additional layer of security, as it subjects the debt instrument to SEBI oversight and requires the issuing company to adhere to stringent disclosure requirements, including reporting financials every three months. Buying unlisted bonds, unless one is a super HNI with specialised knowledge, should be a definite no-go for retail participants.
Matching bonds to your financial milestones
One of the most fundamental principles of bond investing is aligning the instrument’s maturity and features with the investor’s specific financial objectives. Goenka advised: “Match it to your investment goals. See what the maturity of the bond is. Is it 1-year, 2-year, 5-year? Are you saving up for your education? Are you saving up to buy a house?”
This targeted approach allows investors to use bonds to meet specific goals. Furthermore, investors can choose bonds with different interest payment frequencies (monthly, semi-annual, or annual) to match their cash flow needs, such as correlating monthly interest payments with EMIs, making the highly customised.
Credit ratings are a vital metric
The conversation shifted to credit risk, which is quantified by credit ratings. Goenka likened a company’s credit rating to an individual’s CIBIL score. He spoke about the direct relationship between risk and return, and said: “Just remember, the lower you go in the rating, the higher risk you are taking. You might get a higher return, but also your risk is higher.”
For risk segmentation, he advised that while investors can find risk-free returns around 6.5–7% in Government Bonds (which are often better than Fixed Deposits), they can seek 7–8.5% in the Double A (AA) segment. He advised retail investors to stay away from the Triple B Minus (BBB-) and lower segments, reserving them for financial professionals due to the highest risk.
One must note that credit ratings are not immune to issues like corporate fraud. Goenka referred to the 2008 Global Financial Crisis, where even highly-rated securities defaulted. However, he said that the regulatory environment in India has dramatically improved post-2018-19, with tighter oversight on credit rating agencies and listing norms, enhancing investor protection. “I think the framework that we are setting in India is quite conducive and beneficial to the investor,” he said.
Safeguarding against risks
When discussing higher-yielding options, Goenka cautioned against two types of instruments and strategies. First, he advised against Structured and Securitised Debt, which are conceptually complex and require “real sophistication to understand”, making them unsuitable for the common retail investor. Second, he warned against Concentration Risk, where investors are solely attracted to high interest rates, leading to a portfolio overloaded with risky bonds.
“Stay away from these schemes which say, ‘Hey, I will buy for you every month or two months a 10%, 11% paper,’ because very soon… you’ll find you’ll have 12 such papers which are triple B and they are very very risky portfolios,” he said. He stressed that diligence is required – investors should not shut their eyes to risk because the return is 15 per cent, but read the credit rating report and company financials.
Some suggested portfolio strategies
He proposed a strategic asset allocation plan with 25–30% of the total portfolio in fixed income assets. Within that allocation, he suggested dividing it across different risk profiles: about 20% for short-term deposits or liquid mutual funds for emergency fund, another 20% for long-term Government Securities to potentially benefit from capital gains in a lower interest rate cycle, no more than 25% in High Yield Corporate Bonds, with a focus on 2–3 year maturities and careful due diligence; and the bulk of the portfolio (35-40%) in Double A (AA) Corporate Bonds for steady income.
While acknowledging that liquidity is a challenge in lower-rated bonds globally, he pointed to the increasing activity in the Indian corporate bond market. However, he reaffirmed that “liquidity is a function of risk” and that investors in high-yield bonds are often compensated for the lack of liquidity.
The safety net of the Debenture Trustee
One of the significant safeguards in the bond market is the role of the Debenture Trustee (DT), a SEBI-regulated entity appointed by the issuer to protect bondholders’ interests. “A debenture trustee is basically your… guardian to the investment. His job… is to tell you if anything is going wrong from the issue side,” he said. The DT monitors interest and principal payments and tracks compliance with bond covenants. In the event of a default, the DT acts as a safety net and becomes actively involved, mobilising investors, enforcing security and initiating recovery on behalf of the debenture holders.
In conclusion, Goenka said the one most important advice to secure a portfolio against volatility is diversification. He cited a powerful example, and said: “If you had bought a corporate bond giving you 10% (last year when Nifty returns were -2%), it would be plus 10%. That’s a 12% return differential and that helps you to offset the downturns…” He said bonds are a necessary component for any diversified financial portfolio, but urged investors to move away from low-return fixed deposits and secure their wealth.