Rising interest rates have created unusual opportunities. Look at the Tata Steel ‘perpetual’ bond that yields over 11%
R Balakrishnan
The measures of Reserve Bank of India (RBI) to combat inflation by monetary tightening have thrown up interesting investment opportunities in fixed-income products. We are bombarded with SMSs and emails about bank deposits that offer 10%-11% annual interest for a year or two.
Some companies are raising money through long-term bonds (of 5 to 10-year tenures or longer) with aggressive offerings. Tata Steel recently raised nearly Rs1,500 crore by way of ‘perpetual’ bonds. It means no repayment of principal ever, unless the company is wound up.
The bonds carry a ‘coupon’ rate of 11.80% pa, payable every six months. Tata Steel has also put in a clause (a ‘call’ option) which enables it to repay (at its instance alone) at the end of 10 years, the principal in full. In case it does not repay at the end of 10 years, the interest rate gets automatically revised to 14.80% pa!
Alas, Tata Steel did not make a retail issue. It placed all the bonds with insurance companies, funds, banks and other wholesale merchants.
The bond is listed and ‘traded’ on the exchanges (Bombay Stock Exchange, I think). So, now one has to pay a price of anything around Rs107 or thereabouts (a premium of Rs7) to buy it. Even after paying this premium, the yield works out to 11% pa, if one assumes a 10-year repayment. If there is no repayment, the simple yield would be Rs11.80 on every Rs107 (or whatever price one pays).
This compares very well with bank fixed deposits (FDs) and fixed maturity plans (FMPs) of mutual funds. If interest rates come down, as I hope they will, I am getting a great opportunity to lock into a high yield for 10 years! And I would sincerely pray that at the end of the 10th year, the company gets into some problems which would make repayment impossible and the bond gets into the 14.80% interest slot! Today, when I put money in FDs or FMPs, the duration is short (one to three years) and, after that, the returns may not be so attractive. Currently, an FMP enjoys a tax arbitrage which would vanish after June 2011.
I have cited the example of Tata Steel bonds due to their attractive features. There are other instruments available with varying yields. The sad fact about these bonds is lack of pricing transparency.
Also, bonds continue to have ‘minimum’ trade sizes. Tata Steel bonds are traded in single deal sizes of Rs5 lakh (face value of the bonds). It is imperative that the regulators remove these stupid ‘ticket’ size considerations for debt instruments. Only then will the debt market expand. So would awareness.
The other interesting thing is that there is no tax deducted at source on the interest that would come to the investor in bonds. These are in demat form, so are easier to manage as well.
Once interest rates start declining, prices of these bonds would go up. So, after a year, if interest rates go down by half a percent, the price of the bond would go up by nearly Rs3 (in the Tata Steel example). So over a one-year period, you would have got a return of nearly 14%-15%! Of course, the risk is that prices can go down, if interest rates keep rising. In which case, one continues to enjoy the promised interest rate on the instrument.
What is the risk? An instrument like this one from Tata Steel would turn out to be disadvantageous, if, at the end of 10 years, the economy is in such a bad shape that interest rates go up to 18%-20%.
So, it is best to put only that part of one’s portfolio in such instruments that is earmarked for low-risk, predictable returns.
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