“Many retail investors cannot invest in bonds because privately placed bonds have a ticket size of ₹1 lakh. Such bonds make up about 98% of all the issuances. Investors should invest in at least 5-6 bonds to create a diversified debt portfolio. However, to do that, investors would have to deploy more than ₹5 lakh, which only a few can do. SDIs with bonds as underlying assets solve this problem for retail investors. Investors can invest in multiple bonds by investing ₹1 lakh”, said Anshul Gupta, co-founder and CIO, Wint Wealth, a wealthtech startup.
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Last week, Wint Wealth launched a SDI-basket of bonds, while another wealthtech firm, GripInvest, originated its maiden SDI-BondX deal in August.
To be sure, SDIs are backed by a variety of assets, including mortgages, auto loans and credit card loans and have been around for a long time. But bonds are a new addition.
How the deals are structured
GripInvest and WintWealth, among other wealthtech firms, serve as originators, playing a pivotal role in selecting and assembling the constituent bonds within the SDI. They use an in-house due diligence framework to select the bonds. They also play the role of servicers, managing the collections accrued from the SDI. Importantly, the servicers can be changed in case the originator faces bankruptcy, thus safeguarding the cash flows for investors.
The originators set up a special purpose vehicle (SPV), which holds the bonds and issues SDIs. This SPV is designed in such a way that its operations are insulated from the financial well-being of the originator. The oversight of the SPV’s operations is entrusted to an independent entity often appointed by the originator. The credit quality of the bond baskets is typically evaluated by credit rating agencies like Icra and Crisil to provide investors with an understanding of the risks associated with these SDIs.
Investors—individuals and entities, such as retail investors, high net worth individuals (HNIs), and family offices— can purchase the SDIs on OBPPs and receive the cash flows generated by these investments.
What’s on offer
The Wint Basket/SDI offers exposure to seven non-banking financial companies (NBFCs)—Aye Finance, Clix, KrazyBee, NeoGrowth, Ugro Capital, Akara Capital, and Vivriti Capital— and so allows diversification in a single investment. It allows investors to participate in privately placed senior secured bonds with a minimum ticket size of ₹1 lakh. Wint tries to ensure that the underlying bonds are rated by agencies, listed on exchanges, and have no default history. Investors can expect a 10.5% XIRR, or external internal rate of return, with monthly principal and interest repayments if there are no defaults. The issue size is ₹9.1 crore, and the minimum investment is fixed at ₹92,388.
Grip’s SDI-BondX offers an opportunity to invest in a diversified portfolio of four investment-grade bonds of Spandana Sphoorty Financial Ltd, Muthoot Capital Services Ltd, Clix Capital, and Satin Creditcare Network Ltd.
If there are no defaults, investors can anticipate an attractive pre-tax internal rate of return (IRR) of 13.0%. They can expect fixed returns through monthly interest payments and scheduled principal repayments. The bonds within the portfolio hold an Icra rating of A-, signifying low credit and default risk.
Risks still exist
One significant and primary concern revolves around default or credit risk at the individual bond level. For NBFCs, there persists an inherent risk of individual borrowers failing to meet their obligations. These defaults have the potential to compromise the efficiency of collections, which, in turn, adversely affects the lender’s financial position. An increase in non-performing assets (NPAs) also contribute to a decline in collection efficiency, posing a direct threat to the NBFC’s financial stability.
Concentration risk is a significant factor to consider. Although investors gain exposure to diverse loan pools across different NBFCs and various business through diverse bonds, it’s essential to note that the returns can be influenced by the highest weighted bond within the SDI. If a particular bond holds a substantial weight, its performance can disproportionately impact the overall returns of the investment.
The structure lacks external credit enhancement mechanisms. The sole credit enhancement available is the collateral linked to each secured bond within the basket. This collateral serves as the only source of credit enhancement for the entire investment portfolio, meaning that the performance and security of the individual bonds within the SDI play a critical role in providing overall protection and risk mitigation.
Prepayment risk is a noteworthy concern that can impact the returns on the SDI, primarily due to changes in the tenor of the underlying loans.
Then, there is the ‘liquidity and price risk’ associated with SDIs in the secondary market. This risk stems from the market’s limited liquidity, making it challenging to determine fair market prices for mark-to-market (MTM) calculations.
Diversification across a pool of bonds or loans does provide some level of risk mitigation; however, three-year cumulative default rates (CDRs) in different rating categories illustrate that the probability of default for a single corporate bond versus a pool of receivables remains relatively similar.
For example, in the case of Crisil AAA-rated bonds, the CDR is 0% for corporate issues but slightly higher at 0.25% for SDIs. In essence, while diversification offers some protection by spreading risk, it does not significantly reduce the overall default risk when comparing single corporate bonds to pools of receivables in the same credit rating category.
Taxation
The interest on SDIs is taxable at slab rate and a TDS of 25% applies on the same. However, since SDIs are listed, gains after a period of 1 year are taxed at 10% as long-term capital gains tax (LTCG). Thus, if you sell an SDI with a gain after 1 year, you pay tax at 10%. In case of debt mutual funds bought after 1 April, capital gains are taxed at slab rate irrespective of the holding period.
How similar products fare
Debt funds provide diversification by investing in various instruments, including government securities (G-Secs) and corporate bonds across maturities and ratings. Risk is mitigated through the backing of G-Secs by a sovereign guarantee and collateral for secured bonds. Ratings may vary across holdings, and the returns usually range from 5-8%. Taxation is based on capital gains at the slab rate, and there’s no deduction of tax at source. Costs include an expense ratio and potentially an exit load.
Nikhil Aggarwal, founder & CEO, Grip, said, “Debt mutual funds often have a large portfolio of bonds. Further, a fund manager is responsible for picking these bonds and deciding how the pooled funds should be invested. On the other hand, in the case of a basket of bonds/ BondX instruments, a curated bond portfolio is offered, wherein the allocation of funds is frozen upfront. This allocation cannot change during the tenure of the instrument. This is similar to how such baskets work for equity stock. The power to select the bonds has been moved from a fund manager to the investor.”
Single bond investments lack diversification, potentially exposing investors to higher risk, especially if it’s an unsecured bond. While some mitigation measures apply to secured bonds, unsecured ones offer no safety nets. Ratings are typically aligned with the issuing NBFC, and returns range from 9-14%. Taxation involves interest being taxed at the slab rate, with a 10% TDS deduction. Costs usually revolve around the margins for OBPPs.
SDI or bond baskets offer diversification by including 5-10 bonds per basket, helping spread risk. Risk mitigants can protect up to 1.1 times the principal for secured bonds, though unsecured bonds still have no safety nets. The ratings are in line with constituent bonds, and returns typically fall within the 8-13% range. The taxation is similar to bonds but TDS, or tax deducted at source, is higher at 25% on interest, with an additional origination fee as a cost.