Corporate Bonds Vs. Securitised Debt Instruments (SDI): Which Is A Better Alternative Investment?

The Fintech revolution has launched many loan products that help entities from different backgrounds gain access to credit. The MSME sector in India consists of 95% of Indian enterprises and accounts for 29.2% of Indian GDP¹. Despite this significance, MSMEs struggle to obtain traditional working capital loans due to the strict rules of traditional banks.

As lending agencies need collateral such as mortgages, share pledges, charges on current assets, etc., there is a need for alternate funding mechanisms. One such product is a Securitised Debt Instrument (SDI). When loans or receivables are securitised, they become financial securities called Securitised Debt Instruments.

This blog will explore securitised debt instruments and understand how they differ from corporate bonds.

What Are Corporate Bonds?

Corporate Bonds are debt obligations when investors lend money to the company issuing the bond, and the company agrees to pay interest on the principal amount. In most cases, the company also returns the principal when the bond matures. Unlike stocks, bonds don't provide equity ownership of the company for the investors. 

Corporate Bonds provide a steady income stream, and the company's profitability does not result in a higher interest payment for investors. They also provide more security, as the company is legally obligated to continue making interest and principal payments even if it has financial difficulties. In cases of bankruptcy, bond investors are given priority over shareholders.

Corporate Bonds: Benefits And Risks

Corporate bonds offer the following benefits to the investors:

1. Steady income stream.
2. Less volatile compared to stocks.
3. Choice of corporate bonds and the option to choose the type of reward.

While corporate bonds provide a reliable income irrespective of how the company performs financially, there are still some risks:

1. Credit Risk: If the bond issuer goes out of business or declares bankruptcy, investors may lose interest payments and, sometimes, the principal amount.
2. Rating Risk: Rating systems may suddenly change the rating of bonds due to unforeseen events.
3. Event Risk: Bond issuers may have cash flow problems that affect interest payments and principal repayment.

What Are Securitised Debt Instruments (SDIs)?

Individual loans and debt are securitised to create Securitised Debt Instruments. Investors who invest in these securities can receive income from the underlying assets. SDIs are asset-backed securities. Banks and financial institutions securitise debt to free up capital and lower interest rates. 

In the securitisation process, multiple types of loans are collected and pooled together in one bucket to create a debt product. Pass-through certificates (PTCs) are issued to interested investors against these securitised loans. Investors can diversify their portfolios by investing in these asset classes, enabling MSMEs to obtain funding according to their needs.

Originating institutions can pool different types of assets backed by loans to securitise. The Special Purpose Vehicle (SPV) buys these assets and issues PTCs to interested investors on the open market. Based on the types of assets, there are two types of securities: Mortgage-Backed Securities (MBS) and Asset-Backed Securities (ABS). The pooled securities are split into tranches to market to investors based on risk levels or other characteristics. For investors, a tranche is several related securities offered together as a part of a single transaction. These SDI tranches usually have different yields, risk levels, maturities, and repayment privileges. 

SDIs: Benefits And Risks

The SDIs benefit banks, SPVs, and investors in many ways. Banks can offer securities at varying risk levels by dividing bonds into risk tranches. SPVs can profit by getting the most value out of previously unavailable or illiquid assets. Investors can determine their risk level and choose the tranches they want to invest in. Some of the key benefits of SDIs for investors are:

1. Diversification by investing in varying assets.
2. Higher yield compared to traditional assets.
3. Access to new markets.
4. Customised risk exposure.

Like any other investment option, SDIs have some risks too:

1. Credit Risk: The underlying asset's credit quality can impact the value of securities.
2. Market Risk: Fluctuations in the market can affect yield.
3. Liquidity Risk: Some securitised assets may have limited secondary market liquidity.
4. Prepayment Risk: Early repayment of mortgage assets can affect cash flow.

Comparative Analysis Between Corporate Bonds And Securitised Debt Instruments

Both corporate bonds and SDIs provide great options for investors to diversify their risks. Understanding the similarities and differences between these two can help you make better investment decisions.

Considerations For Investors

The Indian securitisation market is growing rapidly, as loan securitisation volumes in the final quarter of FY 2022 increased by 50%, reaching more than INR 50,000 crore². Microfinance loans are emerging as a popular asset segment due to the fintech revolution in India. Compared to other developed economies, this contribution is much lower. The Sarfaesi Act, 2002, promotes the securitisation of NPAs regulated by RBI guidelines.

The SDIs provide better yield with low market correlations for investors. Since retail investors can also diversify their portfolios with SDI, there is a need to  evaluate multiple factors before investing:

• Examine underlying asset quality to compare performance and risks.
• Assess the creditworthiness of the issuer and the credibility of the SPV.
• Conduct cash flow analysis of underlying assets or company.
• Compare returns offered by different types of investment options.
• Pay attention to the securitisation structure to understand risk exposure and complexity.
• Evaluate risk tolerance and diversification strategy to find the right investment instrument

Conclusion

Investors must look beyond traditional investment instruments and diversify their portfolios to avoid wealth reduction due to increasing inflation. The high-yielding non-equity market-related instruments provide better returns and offer protection. Many SEBI-regulated investment instruments previously available only to HNIs are now accessible to retail investors. Investors can continue using their Demat account and invest in SDIs listed on the National Stock Exchange (NSE). Corporate bonds continue to provide reliable income even though the yields are lower than other investment options. Retail investors can now use investment discovery platforms to explore alternative investment opportunities offering better yields and diversification. They should carefully examine SDIs and Corporate Bonds and invest per their risk profile and investment goals.

Grip introduced the first SDI listed on the NSE, pioneering SDI investment opportunities in India. Explore different alternative investments with Grip Invest to build wealth without worrying about inflation.

References:

1. Press Information Bureau <https://tinyurl.com/386yzutu> 
2. CRISIL Ratings <https://tinyurl.com/3ssd5mej>

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