Equities are about growth and bonds are about safety. This is the traditional wisdom that permeates asset allocation strategies.
When applied to bonds one has to be careful as safety is not guaranteed. Unlike equities, where returns are volatile on a daily basis, bonds rely on interest pay-outs as regular income which, gives a sense of safety.
While bonds issued by stable Governments are safe, not all corporate bonds can be relied upon for safety. If even safety is a concern, then what life goals can corporate bonds help achieve?
Goals with near term visibility
Goals that can come to fruition within 2-3 years are well served by good quality corporate bonds. Good quality is the key. It refers to a combination of top credit rating, well-established business group, and high integrity management running the business.
These are premium businesses, but unlike equity, where growth from such businesses tends to be relatively higher, the bond yields are relatively lower.
Being of good quality means that the company is able to raise debt at lower rates compared to other riskier businesses and lower-rated companies.
This translates to relative safety for the bondholder. It also means lower returns compared to bonds issued by companies in riskier businesses. At the same time, good quality listed corporate bonds can deliver better returns than bank fixed deposits. Holding them for a period of 2-3 years is tax-efficient as well.
If you have a need that you visualise achieving in this time frame, good quality corporate bonds with matching residual maturity can be bought in the secondary market.
Cushion for long term goals
Long term goals that are more than 5 years away are best addressed through appropriate equity allocation. However, as you get closer to your goal timeline, safeguarding the accumulated profit becomes a priority.
One way to do this is to switch out the goal money into a good quality corporate bond, again with residual maturity matching your goal time frame.
In this manner, your money keeps earning a reasonable post-tax return, with relatively high safety of capital. Choose your corporate bonds with care. Quality should be a priority over returns. Also, ensure that the bond matures around your goal time frame. This is so that it will be less affected by interest rate fluctuations in the secondary market.
There are gaps in your life goals which good quality corporate bonds can fill in. However, there is also a need to be mindful while transacting in these bonds. The biggest hurdle in listed corporate bonds in India is liquidity.
Your way around this is to take the help of an informed advisor who deals in this market or alternatively, hold the bond to maturity at which point the issuer will likely return capital to you directly.