Corporate FDs give better returns than bank deposits...

...But don't go below AA+ papers; opt for longer tenures to avoid re-investment risk

Just like bank fixed deposits (FDs), interest rates on corporate FDs are on a downward trajectory. The interest rates of some corporate FDs have declined by up to 40 basis points (bps) recently. However, corporate FDs issued by non-banking financial companies and housing finance companies  still offer 9-10 per cent interest, higher than bank FD offerings of 8-8.5 per cent on tenures of one to three years. Do corporate FDs still make sense for investors at this juncture?

“Corporate FDs are suitable for investors who are comfortable with taking a little risk, as these instruments are unsecured and not regulated by the RBI (Reserve Bank of India), unlike bank FDs. The chances of default remain, so investors should do their due-diligence before selecting the company,” said Ajay Manglunia, senior vice-president at Edelweiss Securities.

Investors need to browse through the financials, credit rating and debt servicing capacity of a firm before investing in it. Investors can lose their capital if the company defaults.

“Even for a top-rated company, the element of risk is always there, as business cycles can fluctuate with the external macro-economic environment. Risk-averse investors would be better off opting for bank FDs, as these come with an added element of safety,” said Manglunia. Bank deposits of up to Rs 1 lakh are insured by the Deposit Insurance and Credit Guarantee Corporation.

According to K P Jeewan, head of fixed income at Karvy Stock Broking, investors should stick to papers rated AA+ and above unless they have a very high risk appetite. “There have been instances of lower-rated papers delaying or defaulting on their payments in recent times. So, investors, particularly senior citizens, should not chase yields and opt for lower-rated papers,” said Jeewan. A AA-rating generally indicates the degree of safety regarding timely payment of interest and principal is strong.

Since interest rates are expected to decline over the next two to three years, investors should invest for three-to-five year durations to lock in at existing rates, experts say. “Restrict your tenure to one or two years for lower-rated companies. Opt for the cumulative option for top-rated companies and non-cumulative option for lower-rated companies. This way, in case of a default, you will at least be able to get some interest portion,” said a former wealth manager. It is better to spread your investment across companies. So, instead of one deposit of, say, Rs 5 lakh, in one company, it is better to break your investment into five deposits of Rs 1 lakh each. “This way, if you want part of the money, you won't have to withdraw the entire investment prematurely. Also, you can spread the credit risk over more than one company,” said Jeewan.

Both corporate and bank FDs can be broken by paying a penalty of 25-50 bps. Breaking a corporate FD might be slightly more difficult, as one might have to write to the issuer directly and request for premature withdrawal. Taxation on both products is also the same, as the interest earned is added to your income, to be taxed in line with the individual’s slab rate.

A better option than corporate FDs, say experts, is corporate bonds, currently giving a coupon of 9.5-10.5 per cent. Corporate bonds are secured and issued for a duration for three to seven years. The duration can even be as high as 10-15 years; so, the reinvestment risk is taken care of. Investors can realise capital gains and sell the bonds on the exchanges at a premium if interest rates fall. However, the flip side is that the traded volumes on the exchanges are often thin, which can make exits difficult, particularly for small investors.