India's largest bank, State Bank of India, has come out with an AAA rated bond issue with coupon of 9.25% for 10 years and 9.50% for 15 years. While this issue may be of obvious interest to all the people who equate investing in equities with gambling, my interest in this issue may surprise some of you who know that equities have always been my first preference. Even more so, Warren Buffett has come out saying "it's quite clear stocks are cheaper than bonds right now”.
They may be in US. But not in India, at the moment.
The prime motivation for looking at avenues outside equities comes from the equity valuations now. The stocks are anything but cheap. The businesses are having a good time and the future looks bright but that's an argument for holding on to your stocks and may not necessarily call for a blind date with equities.
| Index | P/E | P/B | Div Yield | RONW |
|---|---|---|---|---|
| Sensex | 23.75 | 3.79 | 1.05% | 16.0% |
| MIDCAP | 22.05 | 3.3 | 0.80% | 15.0% |
| SMALLCAP | 18.03 | 2.59 | 0.83% | 14.4% |
But why go for fixed income instruments when the inflation is about 9-10% and shows no sign for decline. I hate to give my money at a rate less than inflation. High rate of taxes make it even worse of an option. However, one can't be put all his networth into equities when prices at historical highs. Even if prices go higher than current levels, the road may be bumpy. You would want to have a portion of your money available to you even when the market prices rule out the option of selling your stocks. Benjamin Graham's 25-75 rule has not lost its relevance in 21st century[1].
Currently, fixed income instruments are offering a low yield. For instance, a typical linked Fixed deposit from banks only 6.5% at today's date. The interest rate doesn't go up even for longer term. For instance ICICI Bank currently pays maximum 8%(990 days), SBI maximum 7.75%(8 years). If you withdraw prematurely, you get a rate 1.00% below the contracted rate.
Corporate Fixed deposits are another option but they aren't much better. You sacrifice the liquidity, take higher risk and get a percentage point or two extra.This is where bonds give you an advantage of higher returns and better liquidity. We did see few bond issues in past (Tata Capital, L&T finance, Sriram Transport Finance etc) that offered about 10-11%. However, none of these issues was a clear "buy" give the ratings.
The bond issue from SBI is very attractive. It is AAA rated issue that is sure to draw a large number of investors seeking high returns. Given this, you would see the bond to be listed at stock exchanges without any discount(possibly at premium). This gives you an option to exit any time you want, by selling the bond in the market. This makes it much better than a fixed deposit.
The issue offers investors two options – Series 1, having a maturity of 10 years with a coupon of 9.25% paid annually. And Series 2, which will have a maturity of 15 years, it will provide a coupon of 9.5% annually. The issuer(SBI) has a call option, which means that issuer can buy back the bonds from you after 5 years for Series 1 and 10 years for Series 2. If the issuer opts not to exercise the call option, you will be offered an extra 0.5% for the balance tenor of the bonds.
The bonds are listed and hence it will not attract any tax deducted at source (TDS). The interest gets added to your taxable income and you are supposed to disclose the interest as income from other sources in your tax returns. The bonds do not provide any deduction under Income Tax Act, 1961. If you want to utilize the new section 80CCF, you can invest in IDFC bonds.
Compared to fixed deposits there are two negatives. The bonds are capital instruments and not deposits of the bank and hence, they can't be used as collateral for any loan made by the bank. The bond is not covered by Deposit Insurance as in Banks' Fixed Deposits where investments up to Rs. 1 lakh are secured.
The price of the bond upon listing, will depend on the interest rate movements. If long term interest rates fall, the price will go higher. If they go up, the price will go down. You, of course have an option to hold the bonds till maturity in which case the price movements may not be relevant to you. The interest rates in India, on 10 year Govt bonds are ruling slightly above the mean for the last 10 years. You may look at the chart[2] but don't try to make a guess. [Interest rate movements throw more surprises at bankers than stock movements may throw at you]
Here is the snapshot of the issue
Issuing Bank State Bank of India
Issue Public Issue of the Bonds aggregating to Rs. 5,000 million with an option to retain over subscription upto Rs. 5,000 million, aggregating to Rs. 10,000 million. The Bank intends to deploy the Issue proceeds to augment its capital base in line with its growth strategy.Stock Exchange proposed for listing of the Bonds: NSE
Issuance and Trading Compulsorily in dematerialized form
Market Lot/Trading Lot One Bond
Depositories NSDL and CDSL
Security Unsecured
Rating AAA (CARE)
Issue Schedule * The Issue shall be open from October 18, 2010 to October 25, 2010 with an option to close earlier as may be determined by ECCB.
Minimum Investment: 1 bond (10000)
Reservation for retail investors(<= 5lakh) : 50%
Terms of Payment: Full Application Amount
The prospectus is available at SBI website under “Announcements”.
References
[1] Graham's 25-75 rule
“We recommended that the investor divide his holdings between high-grade bonds and leading common stocks; that the proportion held in bonds be never less than 25% or more than 75%, with the converse being necessarily true for the common stock component”.
~ The Intelligent Investor
[2] 10 year Govt bond yeild chart
http://www.tradingeconomics.com/Economics/Government-Bond-Yield.aspx?Symbol=INR
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