The IIFL NCD (non-convertible debenture) issue has opened already on 5 September 2012. I have written about it in an earlier article.
Shriram City Union Finance NCD opens on 12 September 2012. Religare Finvest NCD and Muthoot Finance NCD are expected to open for subscription soon. All of them are NCDs issued by NBFCs (non-banking financial companies).
In this article I will cover relevant principles for making safe debt investments. They apply to investing in the recent NCD issues as well as other debt instruments.
Benjamin Graham taught a very famous student at Columbia University business school . That student was Warren Buffett. Surely, most of us know who Warren Buffet is and his proven ability for generating long-term wealth with sound and profitable investments.
Benjamin Graham also wrote a very famous book called Security Analysis.
Principles you should follow for debt investments
1. Safety is measured not by specific lien or other contractual rights, but by the ability of the issuer to meet all of its obligations.
Lien in plain English means the right of the lender to possess the security that is offered by the borrower while taking a loan from lender.
What this principle says is that one should not rely only on the fact that a borrower is ready to make a promise, on paper, while obtaining a loan. More importantly, there should be concrete ability to fulfill all dues and pay timely interest and repay principal to clear the loan.
In his book, Benjamin Graham writes,
…the primary aim of the bond buyer must be to avoid trouble and not to protect himself in the event of trouble.
2. This ability should be measured under conditions of depression rather than prosperity.
This one is pretty self-explanatory. Please read the earlier article at Capital Orbit that talked of the large number of debenture issuing companies that defaulted over 1998-2002 in India.
If you read the old newspaper articles you will see that things can go wrong!
We know that right now there are not too many options in debt apart from fixed deposits. Consumer Price Inflation is higher than what we are earning in fixed deposits. We are facing, what economists call a negative real interest rate (when inflation is higher than the interest you earn in debt).
Needless to say, our wealth is being eaten away by inflation.
Yet, should we act out of desperation?
Benjamin Graham writes,
The fact that no good bonds are available is hardly an excuse for either issuing or accepting poor ones.
Try to see how the company that you are buying a bond or an NCD from will fare in the worst-case.
Are they strong enough to tackle an economic downturn?
Are they strong enough to face headwinds in their industry?
Will they be hit if regulations governing their industry are tightened?
3. Deficient safety cannot be compensated for by an abnormally high coupon rate.
A Corporation Bank fixed deposit for 5 years pays 9% today. The recent NCDs like IIFL CD and Shriram City Union Finance NCD, promise interest rates higher than 11.5%.
Most will say, let us take the extra 2.5%.
But, the right question is, is the debenture issuing company safe?
For the latest set of NCDs, you can say that you will refer to the credit ratings done by the credit agencies – CRISIL, ICRA or CARE.
Remember that credit rating agencies in the US are perceived by many to have been sleeping at the wheel in the years prior to the credit crisis of 2008.
Do read credit ratings. But never rely on credit ratings alone. Do your own study too.
And, yes, if you feel that it is a risky issue, forget the extra 2-3%. It really does not matter.
Do not be tempted by high interest rates on offer if there are too many risks or gaps in information that you cannot understand.
I leave you with a brilliant line that he wrote on investing in bonds (a debt instrument),
Since the chief emphasis must be placed on avoidance of loss, bond selection is primarily a negative art. It is a process of exclusion and rejection, rather than of search and acceptance.
Be a wise investor.
Please read the disclaimer.