Investors in fixed income products have been caught unawares in recent times by episodes like DHFL (money stuck in the company’s non-convertible debentures) or PMC Bank, YES Bank (hurting depositors) or the very recent Franklin Templeton fiasco (investments stuck in six wound-up debt funds).
Conservative investors scouting for safer and more secure fixed income options may hence, be keen on investing directly in government securities that offer the safest option and fixed return over a long period of time. Unlike in the past, investing directly in government bonds has also become much simpler through platforms like NSE goBID, Zerodha, ICICI Securities, and HDFC Securities, among others.
But should you, as a retail investor, directly invest in government bonds? While the procedure for investing in G-Secs has been simplified, understanding the various nuances of pricing, yield and liquidity, may not be that easy. Here is a lowdown on investing in government bonds.
Back to basics
Government securities are issued by the government of India and are available across a range of tenures. Securities that have tenure of less than one year are called treasury bills or T-Bills and those with more than a year are called G-Sec bonds. T-bills do not carry an interest component. These are issued at a discount to their true (PAR) value and redeemed at their true value. In case of longer-dated G-Secs, you are paid interest semi-annually.
These securities are available both in the primary and secondary markets. In the primary market, these are issued through auctions which are conducted by the RBI. There are two types of auctions ― competitive and non-competitive. In a competitive bidding, an investor bids at a specific price or coupon rate. Competitive bids are made by well-informed investors such as banks, financial institutions, primary dealers, mutual funds, and insurance companies. Non-competitive bidding was introduced for retail investors, who lack knowledge to directly participate in the auction. Under this, a certain amount is reserved for retail investors.
Easier to operate
Over the past two to three years, the entire process of buying G-Secs by retail investors in the primary market has become a lot simpler, with various players offering the facility through exchanges as aggregators. Earlier, the RBI had required individual investors to maintain a ‘constituent subsidiary general ledger’ (CSGL) account or Gilt account with the banks or primary dealers (PDs).
ICICI Securities, HDFC Securities, Zerodha and NSE’s goBID are a few options through which retail investors can use their demat accounts to invest money in T-Bills of 91 days, 182 days and 364 days and various government bonds/securities of one year to almost 40 years.
The exchanges open a non-competitive bidding window every week for G-Secs. Bids for T-Bills are collected from Monday to Tuesday and for longer-dated G-Secs from Tuesday to Thursday. G-Secs are credited to your demat upon allotment and all interest payments credited to your bank account. Under NSE’s recently launched mobile app and web-based platform ‘NSE goBID’, after the bids are collected, and the price determined at the end of the week (by Friday), the securities are credited to your account on Monday (following the week in which the bid is placed).
The minimum investment is ₹10,000, upto maximum of ₹2 crore per security per auction. The RBI allows aggregators to recover up to six paise per ₹100 as commission. While a few players charge commission, transacting through the NSE’s goBID is currently free of charge.
Should you go for it?
While the procedure for investing is fairly simple, the other nuances are quite complex.
For one, investors have to first understand the concept of cut-off price. The price a retail investor pays is decided by banks and other financial institutions that participate in the competitive bidding process. The price discovered — also called the weighted average price — is the price the retail investor pays to invest in the T-Bill or G-Sec. For instance, in the recently concluded auction of 364-day T-Bill (April 29) the cut-off price was ₹96.4. The cut-off price on the G-Sec maturing in 2024 was ₹103.8, in the latest auction. Understanding the changing cut-off prices with different auctions and across tenures of government securities can be confusing.
Then there is the concept of Yield to Maturity (YTM) that can be even more difficult to comprehend. Mathematically, YTM is the discount rate which equates the present value of the future cash flows from a bond to its current market price. In effect, this is your return on investment. For instance, in the above-mentioned example, the G-Sec maturing in 2024 and carrying a coupon interest of 6.18 per cent was auctioned at YTM of 5.2 per cent. This implies your effective return on this investment is 5.2 per cent. But if you are just looking at a fixed income over a long period of time, safety of your capital (return of principal at the time of maturity) and plan to hold your investment until maturity, then what really matters to you is the coupon rate of 6.18 per cent that you will get on your investment semi-annually (on the face value).
This difference between coupon and YTM may be difficult to grasp, and hence, ascertain your actual return on investment.
Then there is the issue of mark-to-market losses on the investments that get reflected every day in your portfolio. Remember interest rate movements impact bond prices. When interest rates move up, bond prices fall (as investors flock to newer bonds that offer higher coupon). Even if an investor intends to hold the investment in government bonds until maturity, the daily rise or fall in investment value in the portfolio can be unsettling for a conservative investor. In particular, if there is a sharp fall in value, investors parking money in these bonds for safety of capital may get jittery (much like if your fixed deposits in a bank suddenly show a loss in value!).
Add to this, the very low liquidity (in the secondary market) or near-no exit option in these bonds, and any investor can be left unnerved even more.
For the savvy and very long investor
If you understand all of this and still want to invest in government bonds, then you have to consider the attractiveness of the returns. For instance, in the above T-Bill example, the bond issued at ₹96.4 implies about 3.56 per cent annual return. Banks on average are currently offering 5.5 per cent interest on deposits of less than one year. A few banks are offering much higher rates of 6.5-6.65 per cent too.
Hence, investing in T-bills may not make much sense now.
In case of government bonds too, for securities of about four to five years maturity the YTM is about 5-5.5 per cent (coupon of about 6.2 per cent), which is lower than the interest rates on deposits offered by many banks (6.75 per cent to upwards of 8 per cent). Remember your interest on government bonds is taxable.
However, buying G-Secs could make sense for investors looking for assured fixed income for a very long period — say 15 or 20-25 years — as there are no comparable bank FDs. The current yield on 30-year G-Secs works out to about 6.9 - 7 per cent. This is higher than what annuity products would offer (4-5 per cent returns, even lower in the current scenario).
Complex terms
Cut-off price: What the retail investor pays to invest in T-Bills or G-Secs
Yield-to-maturity: Discount rate equating present value of future cash flows to the bond’s market price
Mark-to-market: Daily rise or fall in investment value due to interest rate movements