History of Bonds, CPs, PTCs, REITs and ETFs
People are always on the lookout for investment options that would increase their wealth and lend them financial security. Financial instruments carry different risk levels and potential returns, which make them suitable for different investment requirements.
Bonds, CPs (Commercial Papers), PTCs (Pass through Certificates), REITs (Real Estate Investment Trusts) and ETFs (Exchange Traded Funds) are some popular investment options in the market.
Here we will focus on their basic features and history, which are essential components to help people better understand these investment options.
What Are Bonds?
First, let us start with a common investment option- Bonds. These are debt instruments where the issuer borrows funds from the bondholder. The issuer must repay the borrowed amount along with interest on the principal either on maturity or as per the predetermined repayment structure.. The interest is referred to as a coupon.
A bond is a formal contract between the bond issuer and bondholder, where the former sets the designated coupon rate, the interval of payments and the maturity date. According to financial experts, bonds are safe investments because they mostly offer fixed interests. That being said, bonds (even the ones backed by a collateral) do carry some risk – they are not even as secure as your traditional bank fixed deposit.
In our country, bonds can be issued by the Central Government, States, municipalities and corporations to fund their current expenses or long-term financial needs. types of bonds Government Securities (G-Secs), Treasury Bills (T-Bills), convertible bonds, corporate bonds, RBI bonds, Inflation Linked Bonds (IIBs) and Sovereign Gold Bonds (SGBs).
Bonds offer a steady stream of income for investors and protection of the capital invested. This makes bonds ideal for conservative investors who do not want to risk their money. Equity investors can also invest in bonds to offset the risks of their portfolios.
Register here and start investing now if you want to invest in bonds at low risks. There are no hidden charges.
A Brief History of Bonds
Now that we have discussed the basic definition of a bond let us explore how bonds became a common investment option in India. In the 18th century, the East India Company introduced the concept of public borrowing in India when they started borrowing money to finance their campaigns in South India.
The first public borrowing was made formally in the year 1867 for constructing railways in India. During the First World War, there was a rise in public borrowing. Coupon rates also varied in India. In 1857, it was 5%, while it came down to 4% in 1871.
In 1935, the Reserve Bank of India took over the responsibility of managing public debt from the Controller of Currency. From 1951 and 1985, the annual five-year plans played a crucial role in determining public borrowing.
During the period of 1985 to 1991, the authorities attempted to align the coupon rates of government bonds with the interest rates in the market after the Chakraborti Committee published its recommendations.
A Brief History of CP (Commercial Papers)
Commercial Papers (CP) are unsecured money market instruments issued as promissory notes for up to a maturity period of 1 year. Commercial Papers are also good investment instruments for investors.
Leasing and Finance Companies, Financial Institutions and Manufacturing Companies are eligible to issue CPs. However, they have to fulfil specific criteria—
(a) The working capital (fund-based) limit of the company from the banking system is not less than Rs.4 crore
Corporate Papers were first announced by the Reserve Bank of India in March 1989 to allow top-rated corporate borrowers access to different sources of credit. The central bank formally introduced CPs to the Indian market on January 1 1990.
(b) The tangible net worth of the company should not be less than ₹4 crore.
(c) The company’s borrowed account must be a Standard Asset by a financing bank.
Initially, only Primary Dealers (PDs) were allowed to issue these instruments. However, since October 10 2010, any financial institution that fulfils the above eligibility criteria can issue CPs. On March 1 2004, the Central Government substantially reduced stamp duty on CPs, which drastically increased their issuances. While the level of stamp duty has been scaled down substantially across various maturities, the rates as applicable to non-bank entities are five times higher than those applicable to banks
A Brief History of PTC (Pass-through Certificate)
In India, securitisation was started a few decades after 1970 when they were first introduced in the USA. In 1991, Citibank made the first authorised securitisation from its auto loan portfolio. From 2006, the market was regulated, and in 2012, new changes were implemented after the global financial crisis.
A PTC (Pass-through Certificate) is a financial instrument that allows the certificate-holder/investor to receive a fixed income from its proceeds. Investors receive this certificate against mortgage-backed securities of the issuer.
We have to understand a concept called securitisation to understand PTCs better. It is the process of pooling and restructuring homogenous and illiquid financial assets into marketable debt instruments that people can purchase. When investors purchase these debt instruments, they receive a PTC from an SPV (Special Purpose Vehicle), whose purpose is to issue these debt instruments.
A Brief History of REIT (Real Estate Investment Trust)
SEBI (Securities Exchange Board of India) introduced the idea of REITs in India in 2007. With its increasing popularity, the regulating authority finalised the regulations and guidelines to facilitate its smooth operations by 2016. Real estate developer Embassy Group launched India’s first REIT in 2019 with the backing of Blackstone, a global investment firm.
REIT (Real Estate Investment Trust) is an entity that owns and develops income-generating real estate for its investors. The main objective of an REIT is to acquire, lease and manage a number of properties (mostly commercial) on its portfolio in order to collect rental income.
An important benefit of REITs is that it lets investors gain exposure to real estate without the burden of purchasing or managing the property by themselves. Moreover, they are listed on the stock exchange so that they can be sold for a profit.
A Brief History of ETF (Exchange Traded Funds)
ETF (Exchange Traded Fund) is a basket of securities that one can trade on stock exchanges. ETFs track and replicate the performance of indices such as Nifty 50 or Sensex to generate market-linked returns. ETFs are passively managed, and their prices continue to fluctuate throughout the day, just like any other common stock. They typically carry lower fees and higher liquidity than mutual funds.
The global economic recession in 2008 and its subsequent period resulted in the rise of the popularity of gold ETFs. With increasing awareness about ETFs being a lucrative investment option, the Government of India launched CPSE ETF (Central Public Sector Enterprise Exchange Traded Fund) in 2014.
Knowing how investment options such as bonds, CPs, PTCs, REITs, and ETFs came to be helps with understanding their current state in the market. While some of these options are relatively new and relatively unknown, others have caught the attention of many Indian investors. However, before you make a decision on which option to choose, you should consider your own risk appetite, investment goals and preferred tenure.
Frequently Asked Questions
Who are the major players in the G-sec market?
Important players in the government securities market are commercial banks , primary dealers and institutional investors, for example, insurance companies. Other market participants include regional rural banks, cooperative banks, mutual funds, provident and pension funds.
Who can invest in Commercial Papers?
All Indian residents can invest in Commercial Papers. Moreover, non-residents can invest in CPs under Foreign Exchange Management Act 1999.
What are asset-backed pass-through certificates?
Asset-backed PTCs are certificates with tangible assets as their underlying securities, for example, home loans, commercial loans and auto loans.
What are the various parties to a REIT?
Various parties to a REIT include trustees, sponsors and managers. SEBI has formulated REIT Regulations and circulars that mention their responsibilities and roles.