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How good are state bonds?

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The main features

Security: In November 2019, when RBI allowed retail investors to buy SDLs, central bank governor Shaktikanta Das clarified that this instrument is not risky at all. “There is an implicit sovereign guarantee in them,” said Das.

SDLs are as safe as G-secs because states are considered sub-sovereign. “On the due date of repayment, RBI automatically debits the state government account and makes the repayment. So, there is an implicit sovereign guarantee… they would not and cannot be considered risky,” Das said. Debt fund managers agreed. According to Dwijendra Srivastava, chief investment officer (debt) at Sundaram Mutual Fund, SDLs are considered safer than central government entities like public sector banks. “Institutional investors believe that as long as the government of India is solvent, so will be the states. The centre will not let them fail,” said Srivastava.

Yields: SDLs usually give higher rates than G-Secs. Higher the liquidity of the papers, lower are the rates.

According to debt fund managers, papers of developed states with bigger manufacturing sectors such as Gujarat, Karnataka, Tamil Nadu and Maharashtra are more in demand. As there’s demand, there’s also liquidity in the secondary market for papers of these states. The yields on them, therefore, could be lower. “Smaller and developing states that don’t have high liquidity in the secondary market raise funds at slightly higher interest rates,” said Arvind Chari, head, fixed income and alternatives, Quantum Advisors Pvt. Ltd.

Tenure: States usually raise funds for a minimum tenure of four years. But most of the auctions are, typically, for a 10-year tenure. For retail investors, the minimum bidding amount is 10,000 (face value of the bond) and after that in multiples of 10,000. RBI allows exchanges to recover up to six paise per 100 as brokerage, which comes to 0.06%.

The problems

Liquidity: In India, the secondary market for G-secs, treasury bills and SDLs is dominated by institutional investors. “They typically deal in a lot size of 5 crore or more. It is, therefore, difficult for retail investors to liquidate SDLs,” said Vikram Dalal, managing director of Synergee Capital Services, a dealer and an adviser of fixed income securities.

Investing process: To invest in these bonds, retail investors need to sign up either on the BSE platform called BSE Direct or National Stock Exchange’s NSE goBID. These platforms also offer G-secs and treasury bills.

Just like stocks are held in a demat account, bonds are held in a subsidiary general ledger (SGL) account. The stock exchanges act as facilitators or aggregators. They take bonds into SGLs and then transfer it into demat accounts.

“Opening an SGL account can be tedious. Another option is to approach a dealer who will transfer the securities from the demat account to its SGL account. But for this, the dealer can charge a commission of 0.5-1% depending on the lot size,” said Vikram Dalal. He advises against investing in SDLs until the secondary market for the security picks up.

The alternatives

There are several options that are as secure as SDLs and even give higher yields. “Given that SDLs are not liquid and have a long tenure, retail investors should look at alternatives,” said Malhar Majumder, a Kolkata-based financial planner, and partner, Positive Vibes Consulting and Advisory.

The first option is the 7.75% savings (taxable) bonds, which also have an implicit sovereign guarantee. You can invest a minimum of 1,000; there’s no upper limit. The bonds can’t be liquidated or traded during their tenure of seven years. But those between the age group of 60-70 years, 70-80 years and above 80 years can redeem after six, five and four years, respectively.

The second option is post office deposits of five years, which offer 7.7% at present. The third option is Bharat Bond Exchange-traded Funds. The mutual fund scheme comprises of only government-backed companies, which minimizes the default risk. Though you can transact on the stock exchanges, look at this option if you can stomach some volatility in your debt investments.

When investing in a fixed-income instrument, don’t just go by the interest rates. Look at the risk it carries and whether it can be liquidated easily.

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