What do you do when you don't want to miss out on market opportunities and you don't have enough knowledge to make a well-informed decision? You buy a Mutual Fund!! Have an experienced fund manager manage the funds while you just pour in the money (A luxury only a few can afford). The mutual fund also gives you a sense of security as the entire premise rests on the theory of diversification. The fund generally holds a portfolio of multiple industrial sectors with an allocation between debt and equity. to put it crudely it gives you partial ownership of a stock whose prices might be soaring and buying a single unit is out of reach. In short, the upsides are too attractive for an investor.
Bond is synonymous with debt when it comes to investing. It is a glorious loan where the word interest is replaced with coupon and amount borrowed by par value/face value. Like all loans bonds too have a maturity date when the face value is paid to the investor. Well, there is a type of special bond called the 'Perpetual Bond'. As the name suggests the bonds don't have a maturity date. The fact that the holder will keep on getting the coupons at a fixed intervals for an indefinite period makes these bonds attractive. This type of bond has been in existence since 2007 when it was first introduced to help the PSB raise additional capital. Like all innovations the market was skeptical about this new product and to make it sellable the feature of 'call' was added. This gave an option to the borrower to buy back the bond in the future, say 5-10 years down the line.
Although there was no obligation on the borrower to repay the debt ie pay the principal amount to bondholders but investors put their faith in the 'signaling theory'. If a callable bond is not called then it gives a signal that the borrower doesn't have the liquidity to pay off the debt, this will in turn have a negative effect on their stock price. This type of bond was used effectively by the banks to meet the stringent capital adequacy norms that were set after the 2008 crisis.
Recently SEBI stirred the pot by coming up with regulatory change by saying that 'At the scheme level, no fund shall hold more than 10% of its NAV of the debt portfolio in such instruments and not more than 5% of its NAV issued by a single issue'. At present, there are about 20 schemes whose exposure extends beyond the proposed limit. In order to meet this new threshold of 10%, these schemes will have to sell off their bonds. The question is once the panic sale gets triggered, who will buy such large quantities.
Look at it from the issuer side, the banks use these bonds to raise capital at a low borrowing cost. If the banks redeem the bonds then they will have to raise capital from some other source which will increase the borrowing cost. Obviously, they are not going to bear the additional cost, hence the interest rate for loans will increase. Do we need the rates to go up? No, the pandemic shrunk the economy and shut down many small players, in such situations we need ease of borrowing so that the small business can again rise up and attain stability.
Moreover, the SEBI guidelines said that the bonds even though are perpetual in nature, need to be valued at 100 years. What discount rate are you going to use? How can anyone predict forward rates for a period spanning up to 100 years? The callable feature gave some hope that the principal amount will be recovered in 5-10 years and valuations be done accordingly. Now that SEBI has stated clearly that we can't expect to see the principal amount for the next 100 years from the date of issue.
We agree that this type of bond is filled with risks and maybe SEBI wants to address this by bringing in such changes. Remember Yes Bank and DHFL. There was a big question mark on their ability to function as a 'going on concern' which is one of the important underlinings of perpetual bonds. In the case of Yes Bank, the RBI bailed it out and then wrote off all the existing perpetual bonds!! Just like that, the entire obligation on the part of the Yes bank vanished into thin air.
We realize that the bonds are risky in nature and safeguarding the interests of the retail investor is important, at the same time we can't deny that these bonds are a cheap source of finance and needed to boost the economy. Maybe the SEBI can look into incorporating some sort of 'put option' into these bonds to make them attractive and less risky….
Tags :shares stock