In the previous article, we learnt what Corporate Fixed Deposits are, how they work and how useful they are to the investor looking for guaranteed returns with relative safety. This article is about how to choose a good Corporate FD for Investment and most importantly how to weed out impending disasters. After all, it is our hard earned money and we have every right to check and ensure that our money is not invested in a disaster.
Corporate Fixed Deposits are similar to Bank Fixed deposits with the difference that, they are offered by corporations instead of banks. Typically a corporate fixed deposit offers much higher return than a bank FD’s, however it comes with a risk.
This is because corporate deposits are unsecured in nature and unlike bank fixed deposit it is not covered by a guarantee from the Deposit Insurance and Credit Guarantee Corporation of India, which assures repayment of Rs 1 lac in case the bank defaults.
Remember the Previous Post?
How to Choose a Good Corporate FD?
There have been instances in the past where companies that have offered very high returns but have defaulted on both interest and principal repayments. A lot of people have lost their money by investing in such schemes. So, as a smart investor, the onus is on us to study the company and make an informed decision before you make the investment.
Below are some basic things that we must check before we decide to invest in a corporate FD:
1. Check The company’s History – Any company that has a strong track record of successful performance and profit generation for a period of at least 10 years would be a better choice than a newer company that is yet to establish itself
2. Check the Company’s Repayment History – If the company has already issued such FD schemes, check if they have made timely interest payouts and proper principal repayment. It will give you a good idea as to whether they will do the same with our deposits.
3. Check the Issue Credit Rating – Credit Rating Agencies in India like CRISIL, CARE, ICRA etc offer credit ratings on such corporate FD issues. It will be a good idea to check the credit rating of the issue and choose one that is of a higher rating. These credit rating agencies make our lives easier by studying the company extensively before arriving at the rating. So, the chances are that a AAA rated deposit will be much safer than one with a AA rating, even if that means you earn a lesser rate of interest. Usually company’s with lower ratings offer higher interest rates to attract investors for the additional risks they are taking. So, unless you are an high risk investor, stay on the high risk rating grade of AA or even better AAA
4. Check the Sector Outlook of the Company – A company is rarely a standalone entity. The performance of a company is strongly tied to the performance of a sector as a whole. For ex: the Aviation Industry is going through turbulent times right now. Remember the Kingfisher airlines saga that has been going on for the past few months? With the whole Aviation sector going through tough times, chances are that, any aviation company that is coming up with an FD issue may face difficulties in honoring their interest payment commitments. So, make sure that you study the sector of the company and figure out if the sector is expected to perform steadily over the next 2-3 years
5. Choose a Medium Term Investment – Always select a 2-3 year timeframe while selecting Corporate FD options. Though some might consider 2-3 years as long term, in industry parlance, it is not really long term. By choosing such a tenure, you have the option to revisit your decision when it is time to redeem your investment. If you feel that the company or the industry as a whole isn’t performing well, you can let your investment mature and look for better options. This facility will be unavailable if you go for a 5 or 10 year investment option
I repeat, Credit Ratings are one of the biggest deciding factors while selecting such FD schemes. Investors should invest only in a company having AAA or AA rating. This way you can ensure that your investments are safe. After all, that is the whole point of going for fixed income instruments, isn’t it?
If you are not too sure about the various credit ratings offered by Rating Agencies in India like CRISIL or CARE, don’t worry, there will be an article very soon on that topic…
How to Identify a Potential Disaster?
As suggested at the beginning of this article, there are certain key indicators that can help us spot potential disastrous investments. Some of those signs are:
1. If the Company is offering an interest rate of 15% or more – This is a clear cut indicator that the company is desperately trying to raise money and is willing to offer an unusually high rate of interest to attract investors. Though 15% is a great number as an investor, it is very difficult for any company to pay out such high interests even if they manage to earn an extraordinary profit. So, stay away from such schemes
2. If the Company has a track record of defaulting on interest or principal repayments – This is another clear cut indicator that the company may repeat the same with our money as well. What is point of investing in a scheme that has a high probability of defaulting on the payments they owe us?
3. If the Company is below investment grade (Rated below A) – As mentioned in the previous paragraph, the credit rating is a very good indicator of the deposit schemes performance in the near future. Any issue that is rated below “A” is considered below investment grade and has to be avoided. Usually such a rating is given only if the company has a track record of defaulting on its payments. In such cases the company will offer unusually high rate of interest to attract investors (Either or Both points 1 & 2 will be true). So, stay away from such schemes
Do your homework and ensure that you have all your bases covered before you make an investment decision. Corporate FD’s are a great investment option, provided you choose the right scheme.