Corporate FDs are risky, don’t fall for high returns

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Investors should choose only quality issues on the basis of credit rating and promoters’ track record to ensure stable returns

The race for higher yields is getting increasingly fiercer by the day as investors keep chasing fixed income securities, despite questions that are being raised about the quality of some of the new issuances. Investors, tempted by promises of smarter returns, are willing to test the waters. These investors, tempted by promises of higher returns in an era marked by scorching inflation, are now willing to allocate more to high-yielding deposits issued by corporates and fixed maturity plans offered by asset management companies. The trend is quite at variance with the staid 9-9.5 per cent or so presented by banks.

FDs or NCDs (at any rate, fixed-income papers) offering higher yields are actually a threat to the retail investor’s portfolio as they can upset its stability. Credit risk, owing to possible default in payment of interest or principal, is a major issue for the investor, especially given the vagaries displayed by other asset classes. An investor must keep in mind that a steady 9-10 per cent spells reasonable and deliverable returns — as opposed to an untenable 12-14 per cent, which are being promised by some recent issuers.

Fixed income securities are investment instrument that provides a return in the form of fixed periodic payments and the eventual return of principal at maturity. Unlike a variable-income security, where payments change based on some underlying measure such as short-term interest rates, the payments of a fixed-income security are known in advance.

The leaning towards such securities is evident from the support given to FDs introduced by the likes of M&M and Bajaj. The financial services arms of these groups have lately come up with products with rates that are more than their traditional counterparts. Interestingly, both M&M and Bajaj are rated Triple A. It is always advisable that an investor knows the reasons before opting for these products. Some of the key reasons why some investors are taking to these products, according to Nilanjan Dey, director, Wishlist Capital Advisors, are: Inflation is high, which virtually negates the advances recorded by various other asset classes, there are wild swings in growth notched by equity and real estate. This volatility is absent in fixed income, well rated fixed-income products tend to be stable till their maturity, providing a much-needed, strong foundation for portfolios.

“Almost all classes of investors require these assured-return products. This has been lately demonstrated by major sections of HNIs, MNIs and retail investors. Remember, we are discussing this at a time when mainstream chit funds have collapsed, leading to a resurging interest in even postal deposits. The last time I checked, administered-rate products offered by the post office are still very popular,” Dey said.

The popularity of bonds offered by frontline companies, especially the tax-saving kind issued by public sector outfits, is also worth mentioning in this context.

These bonds have found support among a multitude of ordinary investors, many of whom have been seeking guaranteed returns which come bundled with a tax-saving impetus.

And that’s not without any rationale. “The issuers include well-known infrastructure players that are raising capital. There is assurance of returns. Credit risk — although the possibility should never be forgotten — is perceptibly low and then in many cases, investors want these bonds for the medium to long term, keeping in view their need for generating a regular inflow of income (interest payments),” Dey pointed out.

At the shorter end are FMPs, which are clearly for the more experienced investor who is used to the ways in which asset management companies function. These plans typically provide short-term solutions (especially to corporates). However, higher-duration FMPs have also found new followers.

What should investors do?

The wisest thing would be to choose quality issues on the basis of credit rating and promoters’ reputation. One needs to follow the basic principles of financial planning. And more importantly, an investor needs to ask the question (taking a final call) — “Is this FD/bond in sync with my risk-appetite?” Investors need to keep re-investment strategies ready once the maturity proceeds get credited to their bank accounts. “What will I do with the money now?” should be the moot question.

Talking about fixed deposit schemes of banks and corporate houses, an ordinary investor must remember that for bank FDs, returns are guaranteed and do not carry any market risk. However, the interest earned from fixed deposits is not tax-free and is taxed as per the investor’s tax slab. Bank FDs with a five-year lock-in are also eligible for tax deduction under Section 80(C) of the Income Tax Act. Corporate FDs, on the other hand, offer 1-2 per cent higher rates of interest than bank FDs. But investors should avoid company FDs that do not carry a high rating or are unrated but promise lucrative interest rates — some as high as 15 per cent. Both in case of bank and corporate FDs, there is the option of premature withdrawal. However, in case of early withdrawal, issuers lower the rate of interest by 1 per cent from the original rate. So if you are planning any premature withdrawal, keep that in mind.

Amitava Banik of Amitava Banik & Associates, said, “If you are retired or on the verge of retirement or maybe in the lower tax bracket, you can opt for bank FDs. In case, you have a preference for corporate FD, don’t let your decision be governed and guided by the likely returns but by the track records and high ratings.”



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