Summary of this article
Corporate bonds offer a higher yield than government bonds
The yield premium on corporate bonds is due to the higher risk associated
India’s bond market is now nearly Rs. 300 lakh crore deep. Over the past six months, participation in the bond market, from retail investors and high-net-worth individuals, has risen almost fourfold to around Rs. 1.6 lakhs per month.
With uncertainty and volatility in global markets, more investors have found bonds to be a safer bet, offering fixed and attractive returns. In the US, the Federal Open Market Committee cut the benchmark interest rate by a total of 50 basis points this year, while India’s Reserve Bank of India has slashed the repo rate by 100 bps so far in the year. While some market participants are still of the view that there could be more rate cuts on the way, especially after RBI Governor Sanjay Malhotra earlier last week indicated that there was still room to cut rates after a record low inflation print.
But many market participants are of the view that, though the central bank’s Monetary Policy Committee may cut rates on December 5, the easing cycle is near its end. Experts say this presents an opportune moment for investors who want to invest in bonds to rejig their bond portfolio and switch more to corporate bonds, which offer a better yield.
According to Marzban Irani, chief investment officer- fixed income at LIC Mutual Fund Asset Management Ltd., while government bonds are a safer bet compared to corporate bonds because of the security and higher liquidity of these bonds compared to the latter, for investors looking to take a view of up to three years, corporate bonds seem attractive.
“Rates have bottomed out. So, it's more of an accrual strategy for the next year. So, if somebody wants to take a short-term (view), for up to 3 years, then corporate bonds are attractive,” Irani said. “But if one is looking from an appreciation/tactical point of view or liquidity, then it is more of G-sec."
Compared to government bonds, corporate bonds which are AAA-rated offer a yield premium of 47 basis points for bonds maturing in 10 years. Comparatively, for five-year bonds, the yield differential is over 52 bps currently.
Most experts are of the opinion that bond yields will remain range-bound and will not show much volatility as interest rates are not seen falling significantly from current levels. Additionally, the yield spread between corporate and government bonds is also expected to remain at similar levels, with some bias towards yield spreads narrowing. Some experts believe that investors flocking to corporate bonds to lock in higher yields could lead to a fall in corporate bond yields.
Experts are of the opinion that buying short to medium-term investment-grade corporate bonds could be a solution to make the most of the high-yield opportunity during the next few years.
“In corporate bonds, go in the 3-4 year segment that is the best segment…next one year, rates are expected to be static. So, the 4-year bond that you buy today, 1 year down the line, will become a 3-year bond. It will give you protection also if the interest rate reverses,” Irani said.
Though market participants are not expecting any hike in interest rates soon, they said that a safer option for investors was to stay invested in shorter to medium tenure securities, while reducing their exposure in longer tenure bonds.
“A carry-oriented approach, within the overall credit risk tolerance of investors without significant duration exposure, is suited at this stage of the rate cycle,” Rajeev Radhakrishnan, CFA, CIO – Fixed Income at SBI Mutual Fund said.
Demand from institutional investors is also expected to remain firm as they buy bonds to meet their year-end regulatory requirements. “Corporate bonds continue to benefit from regulatory buying and overall,” Radhakrishnan said.
However, some experts were of the opinion that, though investor demand is expected to remain strong in corporate bonds, yields of these bonds may not fall as much as companies typically bulk up their issuances near the end of the fiscal year.
“I suggest investing in Gilts as the Corporate Bond market crops up issues from time to time,” Abhishek Kumar, a Sebi-registered investment adviser, said. “Compared to this, corporate bonds do offer higher yields but also face higher credit and liquidity risk, making gilts relatively more attractive for debt investors.”
