Risk and returns are often said to be the two sides of the same coin. What this means in simple terms is that where there are returns, there is a risk!
The notion of riskless returns is often sought after; however, unfortunately, it is a myth.
Achieving optimum ‘risk-adjusted returns is very much within reach of an investor.
In this article, let us explore a novel concept, covered bonds, that shall help you achieve the optimum returns and, at the same time, put an upper limit to the risk to be taken.
Time for a Fundamental Life Understanding of Risk-Returns
Capital markets and jungles have something in common – both places have animals from multiple species. While this is to be taken literally for jungles, the statement for capital markets should be taken figuratively.
Bulls in markets are the hopeful creatures who seek that extra return and are ready to add on to additional risk. Bears are just like those sloths who keep hanging around on the sides and waiting for a correction.
Then there are pigs, who are highly impatient creatures.
This lack of patience has an obvious consequence – most pigs eventually get slaughtered in this ruthless jungle called markets. Finally, there are turtles. These turtles take their decisions in a deliberate manner.
They understand the consequences of moving too fast. The timeframe for these little turtles is generally long-term. Often, being a turtle is less fancy and glamorous.
No wonder very few investors behave like turtles in markets.
One thing to be noted from this analogy of jungles vs. markets is that investors have different expectations of returns, and their risk tolerance is different as well. We can classify the risk-reward expectations into the following quadrants:
Let’s now talk about the concept.
What are Covered Bonds?
The concept of covered bonds is as old as 200 years in Europe. Within various countries of the European Union, this concept is known by multiple names.
Covered bonds are debt instruments that are issued by the banks or mortgage institutions and collateralized against a pool of assets that, in case of failure of the issuer, can cover claims at any point in time.
In India, the banking regulator Reserve Bank of India has recently allowed corporates to raise funds using covered bonds. The entire concept of covered bonds has gathered steam after the 2008 global financial crisis.
The recessionary times encouraged policymakers and corporates to look more seriously into this centuries-old concept and adopt a policy framework for these instruments.
Let’s Understand the Covered Bond Concept
To understand this concept, let me take you back to a simple secured corporate bond. What happens when you buy a bond?
The answer is you give money to the company, and in return, the company gives you a bond.
Since this bond is secured, the company assures you that they will make good your loss by selling the assets held as ‘collateral’ in case of any unfortunate financial trouble.
Does that mean secured bonds are always ‘risk-free’?
Here’s the catch. Although secured bonds offer a pool of assets to guarantee your investment, the entire process of recovering your capital is long drawn. The process goes through the bankruptcy laws and indeed can be unnerving.
This is precisely where covered bonds come into the picture. Like a simple secured bond, a covered bond offers you a pool of assets to be held as collateral. However, there is one key difference.
In covered bonds, the bond issuer transfers the pool of loans to a ‘special purpose vehicle’ (SPV).
This SPV (also called a Trustee Company) is responsible for ensuring that the investors in bonds get their capital back without going through the long-drawn bankruptcy process in the case of financial trouble for the company. This means that the trustee company gets paid for taking on the default risk.
At this point, you might wonder: ‘What is the difference between covered bonds and simple vanilla secured bonds?’
The primary difference is that covered bonds offer a pool of assets hived off by an SPV. In bankruptcy, the investors of covered bonds need not go through the bankruptcy process to recover their investments. Whereas, in the case of simple secured bonds, going through the bankruptcy route is inevitable.
It can be said that covered bonds are ‘bankruptcy protected,’ whereas normal secured bonds are ‘not bankruptcy protected. No investor in her right mind would like to be a part of the long-drawn bankruptcy process. Would you?
What is the Need for Covered Bonds in India?
At this point, you must be wondering if this is such a fantastic instrument, why is it not popular in India? The answer to this question is that this is a relatively new area of financing in India.
Let me talk a bit about the need for the product in the Indian context.
India is a developing market. Just like every other developing economy, our residents need access to capital for various purposes. Some of the examples are – buying a house, a car, taking personal loans, etc.
The primary responsibility for financing these needs lies with various banks. However, there are areas where banks cannot establish their presence. In this case, non-banking finance companies (NBFCs) have an indispensable role in ensuring access to capital for the nation’s progress.
The business of an NBFC seems very simple from the outside. Ask any industry outsider, and she would say it is so easy! It is about borrowing funds from various institutions/ banks and lending these funds to their different clients.
The company earns its spread in the middle, which is called ‘net interest margin.’
However, the reality is that running an NBFC is a challenging business. One of the main problems that NBFCs face is the ability to raise capital during difficult times.
As the economy goes into a downturn, raising capital becomes difficult. This difficulty is more prominent if the primary source of funding for an NBFC is institutional capital.
This is so because institutional funding is strongly correlated with the overall liquidity in the economy. To overcome this problem, many NBFCs have a strategy of raising funds from retail investors. Retail funding is a more stable source of funding.
The concept of covered bonds and the business model of Wint focuses on this crucial aspect of helping NBFCs raise the much-needed stable capital. Investing in covered bonds is a win-win situation for both NBFCs and investors.
As seen from the above image, the offering by covered bonds provided superior ‘risk-adjusted returns.
Are you an informed investor who likes to weigh your choices carefully before committing your capital? Read-on as I found a startup that’s letting retail investor invest in covered bonds – Wint Wealth
Coming back to the offering by Wint, investors seeking moderate returns and having a moderate risk appetite are relatively undiscovered. There is a valid reason for the shortage of these players in the markets – Indian capital markets offer somewhat lesser opportunities in the moderate risk-return quadrant.
Wint Wealth has a platform that enables investors to invest meaningfully into assets that offer appropriate risk-reward profiles. I believe that ‘returns’ in markets are a byproduct of managing your ‘risk.’
How doe the Transaction Lifecycle Look Like?
There is complete transparency in the process. Wint Wealth is a platform that enables investors to invest their funds in these novel assets. SEBI registered trustees do the money management part.
These are experts in the field of fund management.
The Wint Wealth dashboard also enables investors to check their holdings conveniently.
Important Points to Consider Before Selecting this Asset
Date of Maturity: Just like simple vanilla bonds, covered bonds have a date of maturity. Investors should select those bonds whose maturity date coincides with their expectation of getting the principal payment back.
Interest Repayment Frequency: This is another variable that differs from one offering to another. In some cases, interest is directly paid back to the investors on maturity. Whereas, in many cases, interest is paid back to investors at a regular frequency like monthly.
Rate of Interest: Needless to say, this is one of the most important criteria.
The Pool of Assets (Collateral): As mentioned earlier, the investments made by investors are secured with collateral. It is essential to see what is the underlying asset. In some cases, this asset is gold, whereas in other cases, this could be a portfolio of vehicles, etc.
What are the Risks Involved?
Risk of foul play by the borrower: This risk is omnipresent in almost all investment classes. What is important to note here is that Wint Wealth follows a stringent process before selecting the NBFC.
Regular audits are being conducted to ensure the borrower NBFC meets guidelines. Wint also provides that the issue being floated to their investors is rated appropriately by a credit rating agency.
Liquidity Risk: Early redemption of your investments is possible. This is done from a liquidity redemption reserve that Wint maintains. The interest payable is calculated on a pro-rate basis without charging any extra amount for early redemption.
However, the point to be noted is that in case of excessive redemption pressure, the company may not refund all investors immediately. In this case, investors may have to wait until the maturity of the bonds.
Recent Offering by Wint Wealth
Who’s Running the Show?
A team of passionate individuals runs wint Wealth. A differentiated aspect of Wint Wealth is that the team has a clear goal- providing superior risk-adjusted returns to their investors.
The concept is yet novel in India, and the team is committed to ensuring that their message reaches the right investors at the right time.
The work done thus far by the team has attracted the attention of marquee investors. The presence of these investors adds credibility to the identity of emerging stars in section Wint.
Other than the credibility, the presence of these stalwarts is highly likely to help the team ensure that their offerings are appropriately positioned to cater to investor needs.
Returns without risk are a myth. Wint Wealth is on a mission, and this is complemented by a robust set of early investors and advisors to the team.
It firmly believes in the concept of risk-weighted returns. The platform provides regular opportunities to participate in this fast booming asset class of ‘covered bonds.’
If you have been looking for such an offering, do not forget to check their website here.
Cover Image: Funds Tiger