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Sunday, January 29, 2012

Should you buy these bonds?


Both Hudco and IRFC bonds offer good tax-adjusted returns, but retail investors should buy only if they don't plan to sell them on listing.

The recently ended tax-free bond issues from the National Highways Authority of India (NHAI) and Power Finance Corporation (PFC) have received a good response from all categories of investors, especially the high net worth individuals (HNIs) and institutional investors. While this helped the infrastructure companies to close the issues in advance, it left many retail investors in a quandary because they were waiting to apply at the last minute. As the interest rates have started declining after the issues, experts hope that these bonds will start trading at a premium to their issue prices. "The listing premium of NHAI/PFC bonds should be around 2-3%," says Vikram Dalal, managing director, Synergee Capital Services. However, retail investors don't have to enter the secondary market to buy the NHAI/PFC bonds because two more tax-free bond issues are currently available in the primary market. These are from the Housing and Urban Development Corporation (Hudco) and Indian Railways Finance Corporation (IRFC). 

Why you should rush 
Though the closing date for the Hudco issue is 6 February, and for the IRFC issue, it's 10 February, investors are advised to submit their applications at the earliest. This is because the probability of an early close in this case is also very high and, therefore, anyone waiting for the last minute is likely to be disappointed. As per the offer documents, the issuer has the right to close before the stated date, subject to the condition that it remains open for a minimum of three days. There is also another reason for this rush—both Hudco and IRFC bonds will be alloted to the investors on a first come, first serve basis up
to the limit reserved for each category of investors. So, the early birds will get the allotment. 
Lower rate 
The retail investors who apply for these bonds, including the Hindu undivided families (HUFs) who can invest up to 5 lakh should be a little 
more careful this time. This is because the higher rate offered to retail investors is applicable to the first allottee only. Anyone who buys these bonds from retail investors will only get the lower rates applicable to other investors' category. This implies that the price offered will also be less, so you should be ready for a much lower listing premium compared with that of the NHAI/PFC bonds. Though this should not affect the long-term investors, who are ready to hold these bonds till maturity, it may be a hindrance for those who want to sell it on listing. 
Other features 
Note that there is no cumulative option in these bonds and the interest payment will be on an annual basis. Though these bonds are available in dematerialised form, 
investors can also apply for them in the physical form, if they so desire. The minimum investment amount is 10,000 for Hudco and IRFC, but there is a minor difference. In the case of Hudco, investors can subsequently apply in multiples of 1,000, while for IRFC, it has to be in multiples of 5,000. There is also a difference in their rating levels—while IRFC is AAA rated, Hudco is only AA+ rated. "Since both are central government undertakings, there is no problem with their credit quality," says Dalal. Since Hudco is offering a bit more, you can settle for it, especially ifyou have to choose between the two due to lack of resources. 
Lock in at higher yields 
The timing of these bond issues is very important. The RBI has cut the cash reserve ratio in its previous policy review meet, and it is only a matter of time before it begins cutting the key policy rates. So, this is the right time to buy for investors who want to lock in at the existing high yields. Since bond price rates and bond yields are inversely related, the fall in interest rates will push up the prices of these bonds. Hence, these bonds also offer a good long-term trading opportunity to investors who want to apply now and sell it after 1-2 years after most of the rate reduction is over. "Once the interest rates start coming down, the prices of these bonds will start going up. Since the interest rates are expected to come down in the next 1-2 years, the combined return on these bonds, that is, the capital gain and interest earned, should be much higher for a 1-2 year holding period," says Virendra Kothari, managing director, Etica Wealth Management. 
Who should apply? 
Remember that these are tax-free bonds, not tax-saving infrastructure bonds and, therefore, the amount invested will not be allowed as deduction from your total income. While the interest is tax-free in these bonds, the interest earned on tax-saving bonds is taxable. So, these will be more beneficial for investors who are in the higher tax brackets. The pre-tax yield for retail investors who are in the highest tax bracket works out to be 12.01% for IRFC bonds and 12.08% for Hudco bonds.





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