Do not invest in NCDs and Tax Free Bonds only for capital gains

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Liquidity is very low in the debt segment and investors might not get the right price

 

With the Reserve Bank of India (RBI) signalling a pause in interest rate increases, bond investors are in good cheer. If interest rates come off over the course of next year, then investors in tax- free bonds and debentures might make capital gains. But experts say one shouldn't look at bond investing, whether tax- free or taxable, for a capital profit as exiting through the secondary market comes with a higher impact cost.

For one, the secondary corporate debt market is not very liquid and trading in bonds are few and far between. Only half of the retail instruments in the debt segment are traded out of 160 that are listed. Besides, tax- free bonds and non- convertible debentures (NCDs) are not as sensitive to interest rate movements like the gilt securities where the liquidity is high. The corporate bond market is low on liquidity, and so the sensitivity for a price rise in the bond market commensurate with the falling in yields is lower.

Due to the infrequency of trading, investors might not get the fair price for a bond they may want to sell in the market. By contrast, the government securities market is highly liquid where the correlation to the movements in G- sec yields is higher. Even small movements in the G- sec yield result in gilt securities making gains or losses.

Experts say if you are investing in NCDs or tax- free bonds purely for making gains in the market, then it's advisable not to do so. Long- term gilt funds are a better alternative. If you are betting on bonds for interest rates to fall, then long- term gilt funds are a better way to invest in the debt market. Corporate debt NCDs might not be a good way to play the fall in interest rates. While some experts reckon liquidity could rise when there's an interest in certain bonds, investors would do well to hold on to longer- term highly rated NCDs and tax- free bonds. Retail investors might not have too much of a difficulty in getting out of these investments. If the trading quantity is high, as is often the case with highnetworth individuals, then the impact cost of selling illiquid investments also rises. Retail investors might not face too much difficult in selling but HNIs could as liquidity is an issue, and selling costs could rise. Experts also say if investors exit from high- yielding bonds when the rate cycle begins to fall, it will be difficult to find good debt instruments, especially tax- free bonds, to invest. Once market yields fall come- off, investors may have to invest the sales proceeds of selling in the market at lower yields, which will negate the entire process of buying tax- free bonds or highly rated non- convertible debentures in the first place. Planning to selling bonds in the secondary market within a year or two is speculative as interest rates have not stabilised. However, buying it with the purpose of getting better returns for a longer tenure, coupled with an option to exit during emergencies, is how investors should look at NCDs

For further information on the topic you can CONTACT Prajna Capital on 94 8300 8300 by leaving a missed call.

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