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    Perpetual bonds are quite a hit with investors in rate-cut season

    Synopsis

    In its purest form, a perpetual bond works like a life-time, irredeemable fixed deposit, with bond holders getting fixed coupon every year.

    ET Bureau
    MUMBAI: Perpetual bonds, a product category long ignored by sophisticated investors, are in vogue these days. The well-heeled have been lapping up such bonds of public sector banks on hopes the yield differential vis-à-vis the 10-year benchmark government bond would shrink as the Reserve Bank of India cuts policy rates.

    In its purest form, a perpetual bond works like a life-time, irredeemable fixed deposit, with bond holders getting fixed coupon every year. In India, due to rate volatility, issuers fix a call option, which could be activated after five or 10 years, giving investors an exit.

    Perpetual bonds, or ‘perps’, are being traded 250-350 basis points (1 basis point equals 0.01 percentage point) above the 10-year benchmark government security (GSec), currently at 7.59 per cent levels. Money managers expect this spread to narrow over the next year or so once the RBI eases monetary policy.

    "These bonds are currently mispriced," said Nikhil Johri, CEO of Trivantage Capital Management, a fixed income portfolio management firm. "We anticipate the perpetual bond spreads to reduce by at least 75-100 bps over a period of 12 to 15 months."

    An investor buying a perpetual bond with yield-to-maturity at 11 per cent (currently) will get better (bond) price when rates fall further. Bond yields and prices move in opposite side. So when rates and yields go down, bond prices move up and vice versa. Investors who bought them before the recent monetary policy meeting last week have already clocked gains with yields falling 20-30 bps since the 50 bps rate cut by the RBI.

    "Investment in any debt security will ring in profits over the next 15 months. Benchmark yields may touch 6 per cent in two years’ time," said KK Mital, investment advisor at Venus India Asset Finance Company.

    Since April 2012, banks — mainly state-owned — and a few companies have raised Rs 17,000 crore through perpetual bonds. Banks raised the money to meet their tier-1 capital needs as per Basel-3 norms.

    Banks with lower capital adequacy ratio have been issuing perpetual bonds at rates as high as 11.95 per cent. Bank of India, one of the first issuers of ‘perps’ in 2014, raised funds at 11 per cent. United Bank, Bank of Baroda, PNB, IDBI, Indian Overseas Bank and Canara Bank raised ‘perps’ offering coupon of 9.25 per cent to 12 per cent.

    Provident funds were the biggest buyers of these bonds till recently but fresh restrictions on debt investments have reduced their appetite for the instrument. "The new PF guidelines restrict investments in lowlyrated papers. New rules also bar PF trusts from investing in bonds below AA rating. Pursuant to this, perpetual bonds are now being down-sold in larger numbers to HNIs and debt PMSs," said Arvind Konar, head of fixed income at Almondz Global Securities, a bond merchant banker.

    Investors prefer perpetual bonds by PSU banks because they are quasi-debt. "The RBI has allowed banks to dip into revenue reserves to pay off coupons on perpetual bonds in times of crunch. We’re advising our clients to invest only in PSU bank ‘perps’; the government will not want these banks to default on their borrowings," said Johri of Trivantage.



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    Download The Economic Times News App to get Daily Market Updates & Live Business News.

    Subscribe to The Economic Times Prime and read the Economic Times ePaper Online.and Sensex Today.

    Top Trending Stocks: SBI Share Price, Axis Bank Share Price, HDFC Bank Share Price, Infosys Share Price, Wipro Share Price, NTPC Share Price

    ...more
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