Corporate fixed deposits appear attractive owing to higher interest rates compared to the same on bank FDs. However, one must know that these are not backed by collateral and are unsecured in nature. Investors rely on the reputation and the credit rating of the corporate when investing in them. However, credit rating agencies have gone wrong on ratings multiple times in the past.
The crisis in Dewan Housing Finance Corporation and subsequent helplessness of investors stuck in its FDs hold a lesson. The rating agencies could not detect gradual deterioration in its financials and failed to give advance warning to the depositors. After the issue was already out in the open, the agencies quickly downgraded the company. However, investors got no time to react to the situation. The Bombay High Court had barred the company to make payments to fixed deposit holders without court's permission.
Investors learned it hard way that they should avoid the lure of higher returns and always consider all involved risks. We tell you how you should approach investment into a company fixed deposit.
Avoid if you are a conservative investor
You cannot compare a company FD with a bank FD as latter enjoys deposit insurance cover of Rs 1 lakh and is frequently monitored by the Reserve Bank of India (RBI). Many a time when banks face a problem, the RBI intervenes with prompt corrective action to bring the bank to normalcy. In the worst case, the RBI also facilitates a merger with strong banks to safeguard depositors. If you are a conservative investor with no wish to take risks, you should stay away from these FDs. "Corporate FDs carry default risks, that is, the corporate not being able to return the money invested for various reasons. By investing in corporate FDs, one is concentrating funds into a specific company, which is risky for the portfolio. Hence, I do not recommend corporate FDs," says Mrin Agarwal, financial educator, money mentor and founder of Finsafe.
Also Read: Is Rs 1 crore enough for your retirement?
Invest only if you understand risks
If you are a financially savvy investor with higher risk appetite and are familiar with risks that these instruments carry then you may consider it under your debt investment portfolio. "Corporate FDs have similar risks as those in bank deposits. The strength of the issuer defines the risk inherent in these instruments. Leaving aside the insurance cover amount, which is minimal, the fact that corporate FDs offer higher returns can be contemplated since risk-adjusted returns are higher," says Sousthav Chakrabarty, Co-founder & CEO Capital Quotient, a Sebi-certified financial advisory firm.
"At comparable risks to a bank, these instruments can yield higher returns. Therefore, these may be suitable for a certain section of investors exploring higher yields in the fixed income space," he adds. However, you should put only a part of your debt investment into these FDs.
Do your research before investing
The DHFL example shows that credit rating agencies are not completely dependable, as things may change rapidly not giving you time to react or adjust. If you are investing in a company FD to enhance the return of the debt portfolio, you should thoroughly understand the financial position of the company by checking its financials. Do your own due diligence not only at the time of the investment but also thereafter; you should regularly check the financial performance of the company. You need to make sure that you study their quarterly results carefully. The moment you see any deterioration in numbers, you may exit the company.
Avoid long tenures and concentration
If you are not much confident about the prospects of the company in the long run but still go for the FD, you better invest with a short-term view. For example, if you book the FD for one year, you will get frequent review opportunity and accordingly, you can reduce or increase your exposure. You should also make sure that you do not invest a large part of funds into one company. You can diversify your FDs across multiple companies to mitigate default risks.