A year back, investor X—who prefers risky bets for high return—had invested Rs 1 lakh in JP Associates. Investor Y, cautious by nature, invested Rs 1 lakh in JP Associates’ fixed deposits scheme offering a fixed annual interest return of 10.50%.
Now, assuming the FD matures today, Mr Y would have made Rs 10,500 (pre-tax) on his investment, while Mr X, who had bought the share at Rs 112 apiece, will be staring at a 40% loss on his investment.
How do corporate fixed deposits work?
Corporate fixed deposits are unsecured loans that do not guarantee anything to an investor in case of a default. When you invest in a bank fixed deposit, the Deposit Insurance and Credit Guarantee Corporation ensures that Rs 1 lakh per bank is repaid to you in case of a default. But there is no guarantee for deposits with companies and NBFCs.
Popular instruments of investment
Corporate fixed deposits (FDs) have gained a fancy among investors because of high fixed returns that these products offer. Typically a corporate fixed deposit offers much higher return than a bank FD; however it comes with a high risk tag.
Why does a company raise money through fixed deposit schemes?
This is usually done when other modes of funding dry up. The stock price may be too low for the promoter to offer shares to new investors. Or it is possible that banks may not be willing to lend money, and if they are, the interest rates would be very high.
In the past, there have been instances wherein companies like Panjon Pharma, CRB Capital, Morpan Laboratories offered high returns but defaulted. Even today there is a noise that one of the real estate companies is not making timely repayment to its fixed deposit investors. However, that does not make corporate fixed deposits a bad destination to park your funds. Just like any other investment, you need to study the company, its credit rating and other parameters, before investing in the FD.
Speaking to Moneycontrol.com, Umesh Rathi, CFP, Arihant Capital has listed some of the key parameters to review the corporate fixed deposit before making your investment.
1. The issuing company should have a strong goodwill and track record in the market and should be running its business for at least 15- 20 years.
2. Only invest in FDs of profit making companies that have a constant dividend paying track record for last 5 consecutive years.
3. Credit rating is one of the important parameters while selecting corporate fixed deposit. The NBFCs that offer corporate fixed deposit has to get themselves rated by the rating agencies such as CARE, CRISIL, ICRA etc., but manufacturing firms have no such compulsion. Assuming a company is rated then invests only in a company having AAA or AA rating and if company is not rated then one should deeply study financial statements of the company. If you are not able to understand financial statement then you can take help of financial advisor or avoid investment in unrated companies.
4. The sector outlook in which the company runs its business should be positive. Avoid troubled or high risk sectors like real estate or microfinance.
5. One should avoid company which is offering unusually high interest rates because generally companies offer higher interest rate to compensate high risk.
6. Check the history of the company, how they have paid the principal and interest to the investors.
Credit rating is your most important deciding factor while selecting a fixed deposit. Understanding different ratings can be difficult for a layman as they may not be well-versed with various jargons and rating numbers. The ratings will be in the descending order, where AAA is the best rating while D is the worst.