The Indian bond market now has many options but should you buy one?

The Indian bond market is exploding with options. If you search on Google for “buy bonds in India”, the first hits and the last three hits are ads by bond portals! Then we have portals that exclusively sell via influencer networks and content marketing.

These bond portals have different offerings, from gilts to corporate bonds to covered bonds (refinanced debt) to peer-to-peer lending. For a simple explanation of covered bonds, see: Is there a place for high-interest rate fixed income products in a portfolio?

The offers from these portals go, “buy 9%, 10%, 12% …. bonds”. Then they claim such bonds are safe, they have done the research to protect investors. The feedback from “investors” claim that these bonds are safer than stocks and more rewarding than bank FDs.

But are such bonds (other than those offered by GOI  or RBI) safe? The short answer is no. In the bond market, the risk premium is measured against sovereign bonds. Government bonds have a sovereign guarantee. Unless the country is in serious trouble, the currency is in deep trouble, or the government is bankrupt, such bonds are “safe”.

Any other bond, including state development loans, is never as safe. A bond offers a higher interest because its repaying ability is lower than that of the central government. This is ironic as we demand more interest from an already troubled entity.

In the case of state government loans, there is considerable borrowing from the central government, so defaults are rare, if not unlikely. However,  in principle, interest payment can be delayed if state finances are in a crunch.

But my loan is secured with collateral. Is this not safe? No, it is not! Collateral is almost always an illiquid asset. So selling it will take time, even if we assume no other legal barriers exist. So if the borrower with collateral defaults, you will get your money back “after some time” – when no one can say. Delay = loss because time is money! Also see: Delay in EPF interest payment: Is there a loss to subscribers?

Here are some thumb rules for buying or avoiding bonds!

• Never buy any bond when you are far away from retirement or when there is no need for income. Bonds pay out interest once or twice a year; these are taxable per slab. Instead, use debt mutual funds. For long term goals, along with equity or equity mutual funds, a debt mutual fund can lower overall risk via regular rebalancing. The lower tax incidence is an added benefit.
• Never buy any bond (or any product, for that matter) by looking at the claims made by influencers or on the product website. All such statements are embellishments.
• If you do not have the patience to read through and appreciate the terms and conditions document (the one that is usually hard to find), never buy any product.

If you chase after high returns without research, you are guaranteed high risks with returns entrusted to luck. Bonds carry hidden default risks. Everything will look rosy and posy when suddenly a default is declared. So we recommend staying swaying from such rosy bond offers.

Those who appreciate diversification, goal-based investing, and portfolio management can afford a small exposure to such bonds if they have an investment strategy. From our experience, most people who want to invest in such bonds have nothing more than a desire to earn high returns to back their eagerness. Then again, small exposures have a small, if not insignificant, impact. This is more to satiate FOMO rather can create any impactful wealth.

Even a well-diversified and well-managed gilt mutual fund that takes no credit risk or a target maturity fund investing only in government debt is largely unsuitable to the typical, lazy investor who wants returns without research, such bonds are a big no-no.