A corporate bond is a category of debt security issued by public and private corporations. The corporations issue these bonds and sell them to investors to acquire capital. The investor buying the bonds acts as a ‘lender,’ and the corporation introducing the bonds is an ‘issuer.’ The corporations use the raised capital for various purposes, such as building a new plant, purchasing machinery, or expanding the business.

The corporate promises to return the investment (principal) on a specified maturity date. Until that day, the corporate usually pays a fixed or variable interest. When the bond expires or reaches maturity, the corporate stops the interest payments, and the principal is returned to the investor.

Unlike equity stock, a corporate bond never gives the investor an ownership interest in the issuing company. Instead, the bond is backed by the corporate’s ability to repay, which relies on its prospects for future profits. In some cases, the corporate’s physical assets may be used as collateral.

Understanding Corporate Bonds

Although corporate bonds are considered riskier than government bonds, in general, high-quality corporate bonds are considered relatively safer yet conservative investments. The bond’s quality is determined by the issuer’s creditworthiness, which is reviewed by a credit rating agency. Credit rating agencies like Credit Rating Information Services of India Limited (CRISIL) and Investment Information and Credit Rating Agency of India Limited (ICRA) do this job in India.

The ratings greatly influence interest rates, bond pricing, and investor appetite. Each rating agency has its own rating system. The top-rated bonds are commonly known as AAA or ‘Triple-A’ rated bonds, while the lowest-rated corporate bonds are called high-yield bonds owing to their higher interest rate. This higher interest rate compensates for their higher risk. These bonds are also known as ‘junk’ bonds.

How to Buy Corporate Bonds in India?

There are a wide variety of bonds available in India. Some include plain-vanilla bonds, Public Sector Units (PSUs), and perpetual bonds. They come with short to long-term maturities, offering a wide range of returns. In addition, corporate bonds open another investment avenue for debt securities, apart from Mutual Funds (MFs).

There are four primary ways to invest in corporate bonds in India.

First, you can subscribe to primary issues floated mostly through private placements. Second, you can invest through intermediaries like bond houses. These financial intermediaries display their inventory of corporate bonds and offer sales in the size that fits only HNIs (High Net Worth Individuals).

Third, you can buy these bonds from Indian stock exchanges like National Stock Exchange (NSE) or Bombay Stock Exchange (BSE) through a broker. The fourth option is online bond platforms like bondskart and the Reserve Bank of India-backed RBI Retail Direct.

The Issues with the Indian Corporate Bond Market

Indian corporate bond market faces liquidity issues. If the trading volume in the equity or government securities (G-Secs) market is taken as a benchmark, the trading volume in the corporate bond market is meager.

On top of that, transactions happen in large sizes in the Indian corporate bond market. It is because ‘big players’ like banks, MFs, and insurance companies, not retail investors, are the investors in the corporate bond market. Owing to the illiquidity of bonds listed at the stock exchanges, the scope for online trading is nil.

With the advent of the latest communication technologies, several online bond platforms are cropping up, enabling you to open an account anywhere at any time.

Another issue with the corporate bond market is the minimum lot size of ₹2 lakh. The rationale behind the minimum lot size is that these bond deals are usually settled through Indian Clearing Corporation Ltd (ICCL). ICCL is the settlement platform of the BSE that accepts payments only through the Real Time Gross Settlement (RTGS) process, which has a threshold of ₹2 lakh.

A Market with Immense Growth Potential

Today, the Indian corporate bond market is a little fragile. But the Proposed Regulatory Framework by the Securities and Exchange Board of India (SEBI) in July 2022 has the scope to make the structure more robust shortly. The SEBI paper suggests that, in some instances, clearing corporations of NSE or BSE can be played by online bond platforms by directly accepting funds from clients and processing over-the-counter (OTC) settlements.

This regulatory framework also takes up the instances of unlisted bonds or the value of the transaction below ₹2 lakh. It is the responsibility of the regulators to take the initiative. If the clearing platforms accept National Electronic Fund Transfer (NEFT) payments, it will pave the way for the regulation of smaller transactions. Uniformity prevails in the system if the regulator compels every bond market participant to execute trades through the stock exchange debt segment or exchange clearing platforms for listed and unlisted debt securities.

The SEBI paper also mentions that the investors would be assured that a regulatory party oversees their bond transactions. According to the framework, online bond platforms can only offer listed bonds or debt securities.

The illiquidity in the secondary corporate bond market is a global issue, and our focus is on further penetration of the primary market. As per a recent RBI report, the Indian corporate bond market has grown nearly fourfold since 2012. The concerted efforts by the government and the regulators took the growth of the Indian corporate bond market from ₹10.4 lakh crore in March 2012 to ₹40 lakh crore in March 2022. The annual bond issuance also rose to ₹6 lakh crore from below ₹4 lakh crore during this period.

Conclusion

A balanced portfolio contains these junk bonds to offset the risk of equity investments. Over time, conservative investors add more bonds and fewer risky investments to safeguard their capital. Similarly, retirees often invest a more significant portion of their assets in bonds to create a reliable income source.

With the expansion of the corporate bond market, the number of issuers and lenders, and the fleet of regulated intermediaries, these bonds offer an excellent investment avenue to diversify your portfolio per your financial needs and plans.

Justin Raj

Alpha Research Team