The unpredictable gyrations of the stockmarkets make debt instruments a secure option. Despite the variety, however, the returns are sluggish. With liquidity levels showing little signs of improvement , use credit-ratings to distinguish the deals from the duds.

By Gautam Chakravorthy

The pitch for debt relies heavily on pinpointing the namby-pambies of the world. Do you, sir, hate taking risks? Do the bulls and bears put the fear of God in you? Of course, you did get more than singed by the great mutual funds crash: how much, really, is the value of your investment today, sir? If you do fit the bill, sir, then debt's the way for you. Okay, equity is riskier-and sexier. We know that-ask anyone who has experienced the sheer adrenaline rush of scanning the pink papers to discover that he is in possession of a 4-bagger stock. Sure, it's a great kick-but then, the stockmarkets can be a scary leveller. Riding the stockmarkets in the country is often akin to bungee jumping: the absolute loss of control when one takes the plunge, the near-death experience when the rope holding you reaches the end of its tether, and the sheer excitement of being alive when you defy gravity and snap back.

Heady stuff, but, more often than not, investors have to put up with a constant yo-yo-like motion-and a lot of the Bombay Stock Exchange (BSE) Sensitivity Index's movements just don't make sense. That's the point: debt may not be seductive. But it is the investment tool for the smart investor. For one, debt instruments-like bonds, debentures, or even fixed deposits with banks, companies, and financial institutions-offer assured rates of returns. These instruments are safe when compared to the stockmarket. Debt instruments are also a good way to hedge your portfolio against the vagaries of the stockmarkets. In sum, we are not recommending that debt should account for all of your investment portfolio, but it should be a crucial component.

In these troubled times for the equity market, issuers of debt have caught on quickly. In 1997-98, companies raised Rs 5,100 crore (or 95 per cent of the money they needed) through public offerings of debt. In the first 9 months of 1998-99, 124 institutions-and companies-privately placed debt issues of Rs 26,179 crore, an increase of 6 per cent over 1997-98. Moreover, UB 99 has given a leg-up to the debt market by doing away with the stamp duty on the transfer of dematerialised bonds, making it easier to trade in them in the secondary market. Concludes V. Srinivasan, 34, Head (Fixed Income), I-Sec: ''While no securities were held in the demat form earlier, issuers now prefer to issue new debt in that form.''

But why, you may argue, should I invest in debt when interest rates are displaying a southward trend? True. After the recent reduction of 1 percentage point in the Bank Rate in March, 1999, the banks have reduced their Prime Lending Rates and followed it up with a corresponding reduction in deposit-rates. The trend is clear: the banks will face increasing pressure on their margins, forcing them to keep deposit-rates low.

Moreover, thanks to sluggish credit offtake, the banks are flush with liquidity, and are reluctant to increase their deposits-base in the absence of an industrial recovery. Thus, deposit-rates may move up marginally if industrial growth picks up. Since the recovery looks like a way off, expect deposit-rates to come down further. This will be accentuated if inflation is kept under control-inflationary expectations are one of the factors driving interest-rate movements.

Points out Sashi Nambiar, 31, Head (Debt), Khandwala Securities: ''While credit-offtake is sluggish, deposit-mobilisation is high, indicating a further softening of interest rates. It is a good time for investors to lock in their money at current rates although, in the long run, equity has always outperformed debt.'' So, individual investors can now put their money into corporate fixed deposits-such as those of the HDFC, L&T, Wipro, the ICICI bond issues, or money market mutual and balanced funds.

Elaborates Sudhir Joshi, 52, Executive Vice-President (Treasury), TimesBank: ''The gameplan should be to earn a positive return by pulling in more than the inflation rate. In future, the list of issuers is going to grow smaller as they have cheap money.'' Debt is also easier to evaluate than equity. Points out S.K. Basu, 50, Executive Director, UTI Money Market Mutual Fund: ''Valuation of equities is a sticky issue, and the value of a scrip does not reflect the true strength of the company.'' Debt, on the other hand, cannot be manipulated.

Agrees R. Ganpathy, 48, CFO, Standard Chartered Bank (StanChart): ''With the credit-rating agencies tracking company performance, investors can actively manage their debt portfolios.'' The Reserve Bank of India (RBI) has mandated that any public issue of debentures or bonds needs to be rated by at least one credit-rating agency. That is, ICRA, CARE, CRISIL, and Duff & Phelps Credit Rating.

Says Rajat Dutta, 38, Head (Corporate Affairs), CRISIL: ''Our cumulative debt outstanding rating as on March 31, 1999, stood at Rs 1,98,000 crore.'' How reliable are these claims? Well, there are numerous instances of the credit-rating agencies having failed in their responsibility to monitor the performance of companies. A case in point is the scam-tainted CRB Capital Markets, which, despite its poor financial state, continued to enjoy high ratings till the very end. The reason: intense competition between rating agencies has led to a dilution of evaluation norms. Shaken by these findings, these agencies are pulling up their socks and have switched over to active monitoring, which has resulted in large-scale downgrades.

Warns Anando Bhaumick, 32, Vice-President, Duff & Phelps Credit Rating: ''A rating monitors the performance of the company, and any new circumstances not considered earlier will warrant a fresh review.'' The importance of the credit-rating agencies cannot be underestimated if the rating AAA-low risk, low returns-is to mean anything to the investor. For, credit-rating continues to be the only-and most important-source of risk-evaluation by a third party. Given that, have our credit-rating agencies gotten more reliable?

We would give them a rating of B+, implying that a lot of work remains to be done before investors can really match their risk-profiles with returns. Agrees Ajit Kucheria, 35, Managing Partner, Ajit Kucheria & Associates: ''Even after an agency assigns an AAA rating to an institution like the IDBI, I advise my clients against investing in such paper. We recommend that our clients invest only in AAA-rated institutions; that too, only if they come within the top three ranks.''

This confusion is compounded by the growing options the investor has. On top of the heap are the bonds issued by the leading financial institutions. With concessional financing no longer available, the financial institutions are increasingly tapping the retail market to find their resources. For instance, in the past 12 months, there has been a Rs 3,000-crore issue by the ICICI, a Rs 2,500-crore issue by the IDBI, and a Rs 1,000-crore issue by the IFCI. All 3 were oversubscribed.

That is because the financial institutions are perceived to be safer and more resilient than corporates. Argues Nachiket Mor, 36, General Manager, ICICI: ''The returns offered by the financial institutions, when taken into account with safety, increase the attractiveness of the instruments.'' Institutional paper comes with the added features of long tenures-10 to 25 years-and is listed on the major bourses, offering easy liquidity.

For instance, several bonds issued by the IDBI and the ICICI are listed both on the BSE and the National Stock Exchange, giving investors exit options. The ICICI's Encash bond-with a face-value of Rs 5,000 and a starting yield of 11 per cent, which increases to 18 per cent by the fifth year-offers an an early encashment facility after 12 months through any of the branches of the ICICI Bank. Indeed, the biggest spin-off from the institutional interest in the bonds market is increased liquidity for investors.

Of course, it is still early days, but by offering buyback and call-and-put options, the financial institutions have changed the texture of the debt market. While greater liquidity is welcome, in general, the secondary market for debt continues to be highly illiquid. Despite the large number of bonds listed, trading is minimal. The retail investor is simply not interested in trading; he prefers to hold investments till maturity and earn income. This will only change when investors are offered viable exit-options. While the institutions offer myriad trading options to the consumer, they still exist largely on paper. The impetus for greater liquidity will have to come from the investor, who seems to think that debt equals illiquidity.

In a sense, the changeover has begun. Look at the innovative new deposit instruments being offered by the bank, largely the foreign and private-sector ones. Essentially, the schemes allow the customer the flexibility of withdrawing his deposits in units without breaking the entire fixed deposit. The RBI also allowed banks the flexibility of offering 15-day deposits, which enables customers to earn a higher rate of interest than the savings bank account of 4.50 per cent. These changes make sense in the light of the whopping Rs 1,00,000 crore that was dropped into the banking system's time-deposits in 1997-98. Despite the higher return offered by the mutual funds (9-12 per cent on fixed income schemes), bank deposits (9-11 per cent) still continue to be the preferred source of investment thanks to their liquidity.

Debt-based mutual funds do not lag far behind. Avers R. Sukumar, 34, Fund Manager, Kothari Pioneer Mutual Fund: ''Mutual funds are better than fixed deposits.'' Adds Vishu Deuskar, 45, Managing Director, ABN-AMRO Securities: ''The advantage of mutual funds is that units are more liquid than non-convertible debentures.'' Mutual funds score over bank deposits too as their returns aren't subject to tax-deduction at source; interest from bank deposits is.

What's more, the net asset values of debt-oriented mutual funds show that they out-perform equity-oriented schemes. Most income funds (with pre-dominant investment in debt) gave returns ranging between 11.30 and 12 per cent in 1998-99. However, certain issuers of debt have fallen on bad times. In the late 1980s and early 1990s, the fixed deposits or bonds of Non-Banking Financial Companies (NBFCs) were in fashion. But then, a couple of scams-like CRB Capital, Hoffland Finance, and JVG Finance-shook investor confidence: their money quickly went back to traditional channels like bank deposits. Not surprisingly, confidence in NBFC paper continues to be low even as stricter RBI norms makes it safer to invest in them.

Differs T. Krishna Kumar, 39, Vice-President, Kotak Mahindra Finance: ''In future, the bulk of capital investment is expected to come from the private sector in which the NBFCs will play a major role.'' He may have a point. Some AAA-rated NBFCs, with good track-records, offer interest-rates of 11-13 per cent per annum, which are comparable with those offered by the financial institutions. In fact, some South India-based NBFCs were forced to close their deposit-mobilisation schemes recently since they were swamped with applications. Despite the occasional bad egg-the RBI's restrictions on offering high interest rates-top-rated NBFCs offer sound investment options.

On the other hand, it is the ravages of the recession that have robbed the good old-fashioned corporate fixed deposit of much of its sheen. Currently, AAA- to AA-rated corporates offer interest rates of 11-14 per cent on their fixed deposits. Many top-rated companies have their loyal breed of depositors. Says S.S. Kelkar, 58, Finance Director, Bombay Dyeing: ''Over the years, we have built a loyal set of depositors who come to us despite the modest returns we offer.'' While paper from bluechips are still good bets, investors would be advised to scrutinise ratings-and track companies' results. The stories of downgrades-Essar Oil, Forbes Gokak, Usha Ispat, Nagarjuna Finance, Mahindra Ugine Steel, or Kirloskar Electric, to name a few-show that high-pedigree debt can be deadly.

Tax-free bonds aren't, however. Although returns are ordinary, traditional options, like the Public Provident Fund (PPF), continue to be popular with individual investors. One reason: while the interest rates on all other government savings schemes have been slashed from 12 to 11 per cent, the PPF continues to offer returns of 12 per cent. Additionally, an investor can hike his internal rate of return from the PPF to a high of 22 per cent by carefully withdrawing part of it (after the sixth year) and re-investing it in his PPF account.

The approval of the Union Cabinet for repealing the Public Debt Act, 1944, and its replacement by the Government Securities Act for better management of government securities is expected to pave the way for the RBI to offer better services to the holder of government securities. The risk perception in the minds of investors about a government security, or bonds issued by financial institutions, banks, or AAA-rated companies, is the same. The biggest deterrent, however, is the interest rate factor. With investors primarily concerned with high returns, they are unlikely to put their money into low-yielding government securities. As Sanjay Bhasin, 34, Manager, StanChart, puts it: ''Although the developments are welcome, there are no tangible benefits to the market.''

Will innovation give debt an old-fashioned kiss of life? Ask any investment banker, and he will tell you that the possibility in debt is far greater than in equity. Debt instruments can be tailor-made to suit the risk-return appetite of the investor. In the last couple of years, plain-vanilla bonds have given way to new instruments like deep discount bonds, mibor-(Mumbai Interbank Offered Rate) linked floating rate instruments, regular income bonds, encash bonds, money multiplier-bonds, flexi-bonds, and Separate Trading of Registered Interest and Principal of Securities.

Says Deuskar of ABN-AMRO Securities, which launched strips: ''Investors can derive benefits from such low-credit risk instruments because they are good for long-term investments.'' Adds Ashish Pitale, 30, Head Of Research, Morgan Guaranty Research: ''In the near future, the investor can hope to see more innovations in the debt segment, which will make his investment profitable.'' Take Commercial Papers (CPs). Issued by corporates to meet their working capital needs, CPs are not offered to individual investors. But they could be attractive because of their very short tenures ranging between 30 days and 6 months, with rates of 9-10 per cent that compare well with bank deposits. Says P.H. Ravikumar, 46, Senior Vice-President, ICICI Bank: ''A small beginning has already been made, with high net worth individuals now opting to invest in CPs.''

Small is right. While certain pockets of the market are innovating furiously, the ground reality remains unchanged. So does your perception of what debt can do for you. True, lots more needs to be created: a vibrant secondary market for debt, liquidity in the system, and watertight rating procedures, for instance. For that to change, investors have to move mountains of perception about the efficacy of debt.

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