Recently I received a mail from a financial advisor that I should invest in corporate bonds for high returns and the advisor gave a few options for investment. One of the options I am reproducing below. Subsequently in this article I shall show you how the information is mis-leading.
The promotional Email information
Earn 11.50% Fixed Interest Income With TATA STEEL LTD
11.50% TATA STEEL LTD
Rating-AA
Interest Rate-11.50%
Interest Payment-11th May & 11th November
Maturity-2021
Facevalue-10 Lakh
Price-105
This looked too good to be true. So I checked up on the website of Tata Steel. And what did I find?
What the Email content means
But first let me tell you what the sender of the email mentioned wanted to convey to the reader. The sender wanted to convey that if you deposited Rs. 10 lakhs with Tata Steel, the investor would get 11.5 % for a AA rated scheme (which is actually very good). Since we are in the month of February 2020, it would mean that in in about 10 to 12 months, in 2021 (the maturity date is not indicated) the investor will get 11.5 % interest, which amounts to approximately Rs. 115,000 (depending on the actual term).
If we go to the website of Tata Steel (https://www.tatasteel.com/investors/investor-information/bonds-information/bonds-information-2018-19/ ) we can see that Tata Steel issued a perpetual (called Perpetual Hybrid Securities – PHS) bond (ISIN: INE081A08173) in 2018 for 11.5 % rate of interest. A perpetual bond is one that does not mature. The money remains invested forever. The investor with liquidity needs however can sell the bond at the stock exchange at the going market price.
The Bond is being sold at the stock exchange and not by the company
The first thing to note is that this is not a new fund offer – and the sale is not from the company. The Bond was sold by the Company sometime in 2018. Today it is available on the Bombay Stock Exchange for buying. The market price quoted by the advisor is Rs. 105. The advisor does not tell us the face value of the bond. Suppose it is Rs. 100.
You actually do not earn 11.5 % – You may earn 7.14 %
Tata Steel will pay 11.5 % on Rs. 100 and not on the market price of Rs. 105. 11.5 % on Rs. 100 is Rs. 11.50. At Rs. 105, current market price the bond is already on the higher side of its valuation. When I go to sell the bond after one year I am more likely to get less than Rs. 105. Given the direction of the short term debt markets, let us hope we get at least Rs. 101. Which means I make a loss of Rs. 4 (Rs. 105 – Rs. 101). I have earned Rs. 11.50 as interest and made a capital loss of Rs. 4, my net earnings are Rs. 7.50. On my original investment of Rs. 105, I have therefore earned a rate of 7.14 % (Rs. 7.50/Rs. 105).
Fraudulent representation by the advisor
But the promotional email gives me the impression that I will get 11.50 %. This is how many investors, who do not make the necessary calculations, end up losing money.
Further the advisor has hidden the fact that 11.50 % interest is to be calculated on the face value of the bond, while the buying and selling of the bond is at market prices.
The promotional email gives you the impression that it is fixed income security, while in reality it is a market linked investment, where the risk is carried by the investor, like in ULIPs or mutual funds.
The promotional email also makes it seem that it is a one year fixed deposit, when in reality it is a perpetual bond. For the investor the crucial difference is that since it does not have a fixed term, the investor has to depend on market prices for getting the principal back, and cannot depend on Tata Steel. The Tata Steel website clearly mentions that this bond has no maturity.
Beware of Fraud
In the email referred to above many more such investment options have been mentioned. All of them have similar misleading information. This is but one example of financial advisors playing on the ignorance of the layman investor which amounts to fraudulent market practices.