A quest for higher returns is drawing India’s retail investors into the world of high-yield bonds, a domain that was traditionally reserved for institutional investors. Experts warn that this journey is often steered by two powerful emotions, namely fear and greed. In the fourth episode of Mint Bond Street Dialogues, presented by IndiaBonds, Vishal Goenka, the company’s CEO, spoke about this emotional balance as the key determinant of success or failure for new investors.
“The biggest mistake that sometimes retail investors make… in finance we talk about a concept called fear and greed. Either we go to fear or we go to greed,” Goenka told Subhana Shaikh, Special Correspondent at Mint.
Watch the full episode below,
While the greed for double-digit returns pulls investors toward these riskier instruments, the fear of missing out, or of losing capital, is often forgotten until it’s too late. A critical error, Goenka stressed, is allowing greed to dictate a non-diversified portfolio. The single largest mistake retail investors commit is creating a portfolio exposed solely to high-yield papers, after ignoring the fundamental principles of asset allocation.
Understanding high-yield bonds
Goenka defined high-yield bonds simply: “Any bond or fixed income investment that gives you high returns is called a high-yield bond.” These instruments are typically issued by companies with lower credit ratings, often in the ‘A’, ‘A minus’, or ‘BBB plus’ categories, indicating they are in their growth stage or have relatively weaker balance sheets compared to blue-chip companies.
The fundamental driver for investor interest is the quest for returns significantly above traditional fixed deposits (6%) or high-rated public sector bonds (7.25%). “Traditionally FDs are giving you 6%. People say, ‘I want 10-12%,’ and if I want that 10 to 12%, I have to go lower rating, higher risk, and higher return,” said Goenka.
Companies issue these bonds to diversify their capital base beyond the banking sector and secure favourable terms, a process that is contributing to capital creation in the economy.
Understanding the risks
The bond market is a $2.8 trillion market in India, yet retail penetration still remains low. Goenka spoke about how education and awareness are very important, especially regarding high-yield instruments. Following the SEBI regulation on Online Bond Platforms (OBPs) in 2022, transparency has significantly improved. Platforms like India Bonds now offer disclosure documents like Information Memorandums and Credit Rating Reports, so that investors can read more about their investments and carry out the necessary due diligence.
He cautioned against being tempted by high returns, and said that investors must understand that risk is inherent in all financial investments. The only truly risk-free option is a government bond. “When you buy a bond, there is a chance that you may not get your money back … don’t be fooled by a high yield,” he said.
The importance of covenants
Goenka called credit ratings for bonds a “smell check” and felt that investors must look deeply into the bond’s underlying contract: the covenants. These are the rules and regulations put in place to protect the lender (the investor). He highlighted three critical covenants that every investor must look for. These are detailed in the rating report and Information Memorandum and include:
Rating Downgrade Triggers: Clauses that require the company to compensate investors (either with higher returns or a buyback option) if its credit rating deteriorates.
Non-Performing Assets (NPA) Level: Specifically for NBFCs, covenants may trigger action if the company’s NPA exceeds a set limit, indicating a decline in the health of its loan book.
Leverage: Covenants specifying the maximum Debt-to-Equity ratio the company can maintain. Lower leverage or tight restrictions are generally safer.
Avoiding some common pitfalls
When asked what is one of the biggest mistakes retail investors make, Goenka spoke about portfolio diversification and said: “Your bond portfolio should not have more than 25% of high yield… you should balance it out by like 8-9% return double A [rated bonds], very comfortable.”
He also gave out a strong warning about the rising risk of unlisted and unrated bonds being sold. His advice is that retail investors must only purchase listed and rated bonds through SEBI-registered OBPs. “Please do not buy unlisted bonds… Unlisted bonds are not regulated… If a company were to do worse you would never know,” he said.
Liquidity and the future
Liquidity remains to be a key challenge for the high-yield segment. While bond investment has traditionally been a “hold to maturity” strategy, liquidity generally follows the rating cycle. He cautioned investors about claims of guaranteed buybacks by some entities, stressing that all such offers are “subject to market conditions.”
On a positive note, he revealed that financial infrastructure is improving. something new is coming soon from depositories in the country where selling a bond will be as easy as a click as buying a bond. So, liquidity is a challenge but we are working on the financial infrastructure,” he said.