To be or not to be, that is the question. The Shakespearean quote can come handy in the fixed-income investments space if one takes the liberty of twisting the clever turn of phrase. To invest or not invest, that is the question for those who are baffled by what seems to be a sudden influx of debentures and other debt issuances. Indeed, the NCD (non-convertible debenture) market is action-packed these days, thanks to a range of companies that are set to mobilise resources from willing investors. The main issue is buttressed by supplementary posers, apt for the retail market — why now? What has prompted corporate houses to attract fixed-income allocations? How should ordinary investors proceed on this front?
Before we delve further, let me quickly remind you that the debt investments space has lately witnessed a lot. Two repo cuts, a shrinking of deposit rates, a modest performance delivered by actively-managed debt portfolios — these have all determined investor behaviour in recent days. The arrival of newer debt-oriented options, especially the ones that yield superior returns, has been welcomed by the market. A number of companies, several of them known for their financial services businesses, have entered the space with debentures. The probability of securing relatively higher returns has been a major prompt. This, when traditional bank deposits are losing their overall appeal (and particularly so after the rate adjustments).
The overwhelming question, naturally, is simple: should you choose to invest in these newer alternatives? Further, what are the possible red-flags, why are not all options suitable for you? For the average investor, the answer lies in credibility and trustworthiness. For starters, he must realise that not every NCD is worth his while, he must learn to skip the potentially dangerous ones (read: the most risky options). In short, credit ratings hold the key.
A quick reckoner on ratings can be considered at this stage. Triple A, the highest notch on the rating scale, is the most trusted descriptor. An AAA-rated security denotes trust; the ordinary investor is well aware that such a security is quite dependable. Credit risk (that is, the risk of default) is the last thing on his mind in such cases.
The same investor nevertheless is fully aware of the fact that a high credit rating means a relatively modest coupon (effectively, the rate of interest offered by the security). In the present circumstances, for instance, an AAA-rated paper will usually not offer double-digit performance. However, a far lower rating (say, BB) is a lot more likely to do so. And that in itself can turn out to be a major attraction for the ordinary participant.
Points to note
The average participant is advised to ascertain the following:
- Promoters’ track record and credibility — is there a history of default? Or have the promoters always met their commitments?
- Maturity profile of the issuance — when will the security come up for maturity, that is, what is the tenure of the offer?
- Frequency of interest payments — how regularly will it pay interest?
- Extent of liquidity — is there an exit window? Is the security traded on the exchange, is there sufficient trading volume?
Interest rate sensitivity
Along with credit risk, which we have mentioned earlier, there will be the other significant element — interest rate risk. In other words, debt is subject to changes in interest rates, which will ultimately influence their market price. Remember, the coupon rate influences the kind of income that will be generated from it. Also, inflation will erode the purchasing power of income. This is the very reason why many investors like the idea of inflation-protected securities. Floating rates are indeed sought after by many.
In this context, it must be mentioned that interest rate sensitivity measures fluctuations in prices as a result of changes in rates. A few key points are paramount.
- The longer you stay invested in debt, the more likely is the influence of interest rates on your valuations
- The financial services sector is traditionally quite sensitive to changing rates. Many of the most recent issues have originated in this segment of the economy
- When interest rates increase, debt prices typically tend to decline. And conversely, when rates decrease, prices usually rise. The market value of an existing debt paper will align with the relative attractiveness of new issuances that offer higher or lower rates