In the vast world of investments, numerous options are available for individuals seeking fixed-income opportunities. From traditional avenues like fixed deposits and government securities to more diversified choices like debt mutual funds, the array of options can be overwhelming. However, a very underrated option that stands out for potential returns are High Yield Corporate Bonds. In this blog, we’ll delve into the world of High Yield Corporate Bonds, exploring what they are, why they might be worth considering, how to assess their suitability, associated risks, and who should or should not invest in them.
Types of Bonds categorized as per their Credit Ratings:
Bonds can be categorized based on their credit rating and yield potential:
- Government Securities: Highest credit rating, lowest yield.
- High-Quality, Lower Yield Corporate Bonds:nvestment-grade with a much lower yield compared to High Yield Bonds. For eg. Bonds of companies like L&T, NTPC, Reliance Industries, etc.
- High Yield, Investment-Grade Corporate Bonds: Offer higher yields while maintaining an investment-grade rating. E.g., Bonds of companies like Navi Finserv, Muthoot Fincorp, InCred Finance, Spandana Sphoorty, etc.
- Very High Yield Speculative/Junk Bonds: High potential yields but come with significantly higher credit risk.
Why Consider High Yield Corporate Bonds?
While there are several fixed-income options available, High Yield Corporate Bonds offer distinct advantages:
- Attractive Returns: High Yield Bonds typically offer higher yields compared to traditional fixed-income investments like fixed deposits or government securities. This means higher income for investors.
- Diversification: Including High Yield Bonds in your portfolio can help diversify your investments beyond equities, making your portfolio more resilient to market volatility.
- Predictable returns: Corporate Bonds can give fixed and predictable returns unlike when investing in Debt Mutual Funds.
- Potential for Capital Appreciation:High Yield Bonds may also offer opportunities for capital appreciation if the issuer’s creditworthiness improves over time.
Checklist for Investing in High Yield Corporate Bonds:
Before investing in High Yield Corporate Bonds, it is important to see the characteristics of the bond that you are looking to invest in. Here, we have created a Ready Reckoner for you so that you check the crucial parameters before considering an investment:
While there are several fixed-income options available, High Yield Corporate Bonds offer distinct advantages:
- Investment Grade: Ensure that the bond is rated as investment grade, indicating a lower risk of default. Prefer bonds that are rated by major rating agencies like CRISIL, CARE, ICRA, and India Ratings.
- Strong Promoters: Evaluate the track record and financial strength of the company’s promoters. The ability of the promoter to infuse capital into the business is a big positive.
- Security: Determine if the bond is secured by assets, which can provide additional safety in case of default. Also, check the extent of the cover that is provided.
- Asset Quality (for Banks and NBFCs):Assess the asset quality by looking at metrics such as Gross Non-Performing Assets (GNPA) and Net Non-Performing Assets (NNPA) for NBFC or Bank issuers. Lesser the GNPAs and NNPAs, the better it is.
- Lender Pedigree:Check the reputation of other lenders involved with the issuer, as it can reflect on the issuer’s creditworthiness.
- Profitability:Analyze the issuer’s profitability to gauge their ability to service the bond’s interest and principal payments. Check whether the issuer is regularly making a Profit After Tax (PAT) and also check the ratios like Return on Assets (ROA) and Return on Equity (ROE) to determine the profitability. The higher these ratios are, the better is the profitability
- Capital Adequacy Ratio and Leverage: A high Capital Adequacy Ratio (CRAR) and low leverage (Debt to Equity ratio) indicate a healthier financial position for the issuer.
- Payment Frequency:Understand both principal and coupon payment frequency, as this can impact your cash flow needs. A frequent cash flow also reduces the default risk of the issuer.
- Other Covenants:There are other covenants (or conditions) mentioned in the Term Sheet of the bond that help in risk mitigation. Some examples are:
- Promoter guarantee
- Higher coupon rates/ Buyback in case of rating downgrade
- Condition that the Promoter cannot dilute their shareholding beyond a certain level.
- Profitability should be maintained above a certain level
- Asset quality should be maintained above a certain level and so on.
Risks of Investing in High Yield Bonds
Like all Financial Instruments, investing in High Yield Bonds comes with certain risks:
| Types of Risks | What do they mean? | How can they be mitigated? |
| Credit Risk | Credit risk refers to the risk that the issuer may not be able to honour the principal and the coupon payments. | Invest in Bonds that are secured and have an investment-grade credit rating. |
| Interest Rate Risk/ Market Risk | Bond prices are sensitive to changes in interest rates. If the bond yields go up, the bond prices fall, and vice versa. | It is advisable to avoid investing in very high-maturity bonds when the credit risk is on the higher side. |
| Liquidity Risk | High Yield Bonds may have lower liquidity compared to more mainstream investments, making it challenging to sell them when you need cash flows. | Invest in Bonds with a view of holding it till maturity. Alternatively, invest with platforms that can give you anytime liquidity. |
Who Should Invest and Who Should Avoid?
A. Who Should Invest ?
- Seeking Enhanced Debt Returns: Those looking to invest in higher return instruments generating 10-12% p.a. returns in a stable manner without the volatility associated with equity investments
- Those looking to beat inflation: While FDs give fixed returns, they hardly beat inflation, let alone create any wealth. Predictability should not be at the cost of returns. High yield corporate bonds offer fixed and predictable returns which comfortably beat inflation and let your capital grow.
- Those able to Hold till Maturity: High Yield Bonds often require patience and a willingness to hold the bond until maturity (typically 1-3 years) to realize their full potential.
- Informed Investors: Individuals who fully understand the risks associated with High Yield Bonds and are comfortable with the steps taken to mitigate those risks
- Diversification Seekers:Investors looking to diversify their portfolio and reduce overall volatility.
B. Who Should Avoid Investing?
- Traders: If you are looking to make quick profits by buying and selling bonds, then you should avoid investing in such bonds. Corporate Bonds are typically less liquid so it is advised that the investments should be made to hold till maturity.
- Emergency Fund Creators:If you are building an emergency fund for sudden expenses, it’s best to stick to very liquid options
- Low-Risk Appetite:Investors with a very low tolerance for risk may find High Yield Bonds unsuitable
Conclusion
High Yield Corporate Bonds can be an attractive addition to your investment portfolio, offering the potential for higher returns compared to traditional fixed-income options. However, they come with their share of risks and may not be suitable for everyone. Before investing, carefully assess your risk tolerance, financial goals, and the specific characteristics of the High Yield Bonds you are considering. With the right approach and understanding, High Yield Bonds can be a valuable tool for diversification and income generation in your investment journey.
