Choosing a Good Corporate Fixed Deposit for Investment

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.

To revise:
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

To Summarize:
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.

Happy Investing!!!

Investing in Corporate Bonds

The bond market is currently abuzz with scores of investors investing money in millions in it. Before getting into the details let us first find out what a corporate bond is.

A corporate bond is something similar to a bank fixed deposit. The company issuing the bond accepts your deposit and issues you a certificate as proof of your deposit. During the deposit the company agrees to pay you an interest for your deposit. You can opt for periodic interest payments or one lumpsum payment at maturity. All said and done, there are a few major differences here.

1. The interest offered by corporate bonds are higher than that offered by banks
2. There is no guarantee that you would get your money back. The bond is issued on a best effort basis where the company would try its best to repay your money along with interest provided it is able to make sufficient profit.

Now you know why corporations offer a higher interest rate “To attract investors who are ready to take the risk by offering a higher Return on Investment (RoI)”

Why are Corporate Bonds so attractive now?

With the ongoing financial crisis, the equity markets have slumped to nearly half of its peak value at the beginning of the year 2008. Most investors have lost interest/faith in the stock markets and are considering other avenues of investment which can provide them better returns. Currently bonds are one among the top investment options because they offer a better RoI than bank deposits. Though they come with an inherent risk, most corporations that issue bonds are in pretty sound financial status and the chances of losing our principal is comparatively low. Since bonds are like bank deposits your capital remains intact and hence bonds have become attractive now.

The bonds that are currently being issued offer us returns of around 11% which is nearly 2-3% more than what banks offer us.

Though the returns on corporate bonds are high, they come with their inherent risks. Below are some aspects that you need to check before investing your hard earned money in them.

Creditworthiness

Default in payment by the bond issuer is one f the major risks that we face while investing in bonds. The default could range from untimely payment of coupons to non payment of principal at maturity.

The chances of default can be found out by the rating assigned to the bond by authorized agencies on the basis of a rating scale. The higher end of the scale indicates better credit quality which means that the chances of default are lesser. Apart from the chances of default, such agencies also consider another risk before assigning a rating. That is the sector specific risk. If an industry is going through a rough patch due to the prevailing economic scenarios then the chances of the company performing well are lesser. Hence this would naturally affect the company’s finances and eventually affect the bond rating.

It is a general thumb rule to choose bonds with good credit ratings over the ones with not so good ratings.

Risk Return Balance

We should analyze our risk appetite before investing in certain bonds. Some company’s offer very high returns but their credit history wouldn’t be so great. Investing in such bonds should be done with caution.

We can compare the returns on existing bonds with a similar rating in the market to find out the kind of returns that we can expect in new issues. But the yield on a particular bond would also depend on the industry in which the bond issuing company operates. For example the yield on an ‘AAA’ bond in a finance industry would be higher than that of an ‘AAA’ bond in a manufacturing industry. But at the same time, investors would prefer manufacturing industry because of the safety of investment and would prefer them over finance bonds.

We must analyze the performance of the issuing company before making our investment.

Exit Options

One of the most important considerations before buying a bond is the liquidity offered. This is important because most bonds are long term investment options wherein your money would get locked in for 5 – 10 years.

Premature selling of bonds would expose us to interest rate risks. For example, when interest rates go up, new bonds start offering higher rates than that of existing bonds. So at such a situation if you want to sell your bond, you would have to sell it for a lower price than what is its current market value.

Also, some corporations may not be able to pay off the bonds if we plan to exit before maturity. Though these securities are listed in registered exchanges, they may not be liquid and you may not be able to sell them at the current market value. You may have to compromise on the selling price while selling such illiquid securities.

Other factors

Some other factors to be considered before buying such bonds are:

• Do not invest in complex bonds. The simpler they are the better they are for you. For example some bonds give us the option of converting them to that company’s shares. This increases the volatility in price of the bond and it is better to stay away from them.
• Industry situation: Always some industries would outperform its peers and some may underperform. Investing in bonds from industries that are struggling would adversely affect both liquidity and returns on our investments.
• Credibility & Integrity of the Rating agency. Do not just go by the rating given by the rating agency. Analyze the credibility and past history of the agency before believing their rating. Also remember that these ratings are only speculations and do not guarantee the bond performance.

Happy Investing!!!