Innovative financial products for Indian investors
Article published as on
Monday, 31st May, 2021 at 7:00 a.m.
EMI / Annuity bonds
Most of the bonds issued and traded on stock exchanges are those that pay an annual interest rate each year and principal payment at the time of redemption or we have zero-coupon bonds which pay the entire amount upon maturity.
On the other hand, when we take a loan we pay installments of equal amount (interest+principal) at regular intervals and pay off the loan in a set amount of time.
So as an investor what if the investor wants both interest + principal repayment over the life of the bond just as we pay off our EMI
We currently don't have any such bonds which offer these qualities, but if such kinds of bonds are issued more and more participants will be attracted to the capital markets.
Example of EMI bonds.
Assume we take a loan of rupees 100,000 for 10 years at an 8% interest rate then we would have to pay each month an installment amount of 1213.2760
In which the component of both interest and principal is paid in the time of 10 years.
If these cash flows were on a bond the yearly cashflows would be of rupees 14,559.3120 meaning an annual yield of 14.56% (this includes 8% interest as well as principal repayment)
Why should such a bond be issued?
Here are the
Benefits of such a bond:
Lower reinvestment risk to the investor:
As the interest and principal are paid together over the lifetime of a bond as compared to one-time lumpsum principal at the maturity investor faces comparatively lower reinvestment risk. As does not need to worry about reinvesting the principal at maturity
Lower default risk
Assuming 2 different 10 year NCD one is the regular one and another in EMI bond.
And the company defaults in the 9th year.
For the regular NCD holder his/her entire principal amount would be locked which he must have got in 10 years, but in EMI bond as the principal repayment is also done only a small fraction of the principal amount would be locked in for this investor.
Higher yield, regular income:
This bond is especially useful to those who looking for regular income. As explained above investor would get a yield of 14.56% (interest plus principal repayment) instead of just 8% interest. This option will give flexibility to investors in managing their cashflows and portfolios.
Diversification:
This kind of option will help diversify the portfolios and also attract more participants into the capital markets.
Discipline even for the issuing companies:
Companies that issue such bonds also don't need to worry about a large principal repayment at maturity, as the principal is repaid over the life of the bond. This ensures discipline in managing cash flows to the issuing company.
Index ETF’s
Apart from these, the general trend of popularity of ETFs is rising but we hardly have any variety and choices over here.
Most of the listed ETF's are nifty index ETFs.
Motilal Oswal did some innovation and launched Nasdaq 100 ETF.
But still if one needs to invest in pharma/ Auto/ IT/FMCG space the only way is through a mutual fund.
Why don't we have ETFs tracking these indexes?
Few reasons are lack of awareness/interest, no SIP option like mutual funds, and low management fees for the AMC.
Maybe for these reasons we haven't seen any innovation in financial products.
(Would you invest in such an ETF if given an opportunity?)
Commodity ETF
Another idea is silver and platinum ETF's
In India, we already have gold ETF's, and sovereign gold bonds (SGB's), and also we might have an upcoming gold exchange where we might be able to buy and sell units of golds just like stocks.
Just like gold bonds and ETF's we could also have silver and platinum ETF's
These ETFs should be issued by mining or jewelry companies against their inventory of these metals.
In this way, they can hedge their inventory and also get funds to run the company.
These ETF's like gold bonds should also pay a rate of interest.
For example, let assume there is a company
Having 10 grams of platinum in inventory valued at Rupees 35,000 issues the platinum ETF of 10 years.
Here the company gets the fund of 35,000 it is as good as if the company has sold the platinum to ETF holders and is just providing the storage facility. Here the company also pays interest on the amount of 35,000 let us say 2% which is Rupees 700 a year.
After 10 years assuming the value of platinum rises to Rupees 90,000 the company can sell the physical platinum it has for Rupees 90,000 and repay the ETF investors the said amount.
Here if some AMC did the same job they would charge storage cost, and asset management expense and for the company,
The company would have to hedge the inventory using futures, but if it needs funds it would have to take a loan at comparatively higher rates, and also if the prices rise rapidly the company would lose money on the mark to market losses on futures.
To conclude:
Thus in this manner, both the issuer and investor would benefit from the introduction of such instruments.
I would like to add recently even in cryptocurrencies one such company is offering interest on deposit of such cryptocurrencies
Even in the stock market, we have such a concept which is SLBM security lending and borrowing mechanism in which the owner of shares can earn some extra income.
The benefit of these products is that as the prices of these commodities rise the value of investment also directly rises.
Similarly, there are ideas relating to ETF for agro commodity and nonmetals.
but for now, these products seem a bit too complex also if they are launched the market opportunity for them seems small.
Just as a pinch of salt adds taste to our food similarly
Even though the market size for these products at present is would be small.
but these innovative products will certainly make our capital market much more interesting, engaging and attractive to investors.
Update as on 15th Oct, 2021
while browsing the list of ETF's on the NSE website (link here), I came across
Nippon Pharma ETF, launched on 2nd July 2021. And
Axis healthcare ETF. launched on 17th May 2021.
We already had ETF's of Nifty Bank, Nifty PSU, Nifty IT now Pharma is also added.
This is good news and hopefully, in the future, we get to see more such innovative and new varieties in ETF's
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