A Rent Past Experience
It will be worth recalling a recent experience of the introduction of a new financial product for retail investors. Every now and then, there are new avenues of investments for the retail investor. A few months ago it was the Alternate Funds which were aggressively sold. The Alternate funds also called Exotic Funds had suddenly found a market and they are not in any regulatory control. Exotic Funds it was reported had grown 71 % in the last 12 months ending March 2019. In June 2019 it was reported they were worth $40 billion. That is 40 billion dollars have been collected from the middle class.
The Exotic Funds, keeping the fancy name aside, are nothing but very high risk loans given to builders and property developers, being sold by NBFCs to generate funds for their fresh lending, as they were unlikely to get their past loans to the builders paid up soon. The financial sector has this wonderful way of putting on new clothes over old torn clothes and now one ever knows the rot inside.
State Development Loans (SDL)
In November 2019, the RBI allowed retail investors to buy the State Development Loans (SDL). The SDL is a bond issued by state governments. The Bonds are being sold as quasi-sovereign guarantee bonds. That is to say, since the bonds are issued by the state governments, and because the hope is that central government is unlikely to let a state government default on its payment. The analysts are presenting the SDLs as good as sovereign guarantee.
Sovereign Guarantee has a Meaning to the Investor
It is actually not so. International Funding agencies do not by an large accept a guarantee from the state governments for funding of projects in India. They demand a central government guarantee. This is because in their assessment the state governments are high risk. There is a big difference between “almost a sovereign guarantee” and a sovereign guarantee. “Almost a sovereign guarantee” is perception, it is mere imagination and hope. A sovereign guarantee on the other hand is a law passed by the Parliament of India – it is rock solid.
SDLs – Low Returns
In the last sale of SDLs, ranging from terms of 4 years to 14 years, the yields were 6.62 % to 7.15 %. While SDLs give a return of more than the government securities, the range of yield mentioned above compares with the fixed deposit interest rates of banks and the bonus rates on LIC endowment policies.
SDLs – Investment Risk
As mentioned above the SDLs carry an investment risk that is recognized globally.
SDLs – Liquidity Risk
In addition liquidity is a problem. While in theory an investor can sell the Bond in the financial market, in practice it is difficult to easily find a buyer. It will be very, very difficult to find a buyer for the SDLs of smaller states. Even the SDLs of the bigger states may not have a ready market. Moreover in the financial markets the main buyers and sellers are large institutions, and they will not have the appetite to buy small holdings of retail investors.
Conclusion
SDLs do not give high returns and are not as safe as deposits in banks or LIC. They also have a liquidity problem. It is not for the retail investor.
Sell Risks Not Returns