Public Sector Undertaking Bonds (PSU Bonds) are debt instruments issued by public sector companies. Investment bankers manage these issues. Most of the PSU bonds are marketed by wealth management and brokers and sold to their clients on a Private Placement Basis. These bonds provide interest at market-determined interest rates and are issued with maturity.
Explanation – What are Public Sector Bonds?
Issued by state or central government Public Sector Undertakings (PSUs), these are medium and long term bonds in which the government shareholding is more than 51%. These government entities can be PSU companies in the power sector, railways, and other sectors.
The PSU bonds are the issues in the private placement market through two main channels:
- Directly with an institutional investor like insurance companies
- Through an agent, typically an investment bank that solicits bids from potential investors.
Brokerage firms buy PSU bonds from financial institutions and fund houses in the secondary market and sell to investors at a higher price.
PSU bond investment is preferred when stock markets are volatile and expected to decline in performance. Hence if you are expecting a decrease in interest rate, then you can buy the bonds for capital gain.
Higher yields than other debt instruments
Yields on many of these bonds are much higher as compared to the market rates. In spite of the brokerage cut, returns on many of these bonds are significantly high. For instance, returns on UP Power Corporation Bonds, 2025 (10-11%), Rajasthan State Road Transport Corporation Bonds, 2022 (9%). Therefore, gaining more interest from investors.
It involves over-the-counter (OTC) transactions. Brokers sell PSU bonds to investors at a lower yield than the yield at which they buy the bond. Here these transactions are not transparent as you will not know exactly how much the broker has earned on the transaction.
Low default risk as they are backed by the government. However, there is no iron-clad guarantee behind them.
Why should you Invest in PSU bonds?
An investment with low risk
Investors with a low-risk appetite looking for higher returns can consider PSU bonds. PSU bonds come with minimal credit risk because these bonds are backed by the government.
Suitable for High-income taxpayers
One of the most common reasons to prefer PSU bonds is taxation. Long term investors who are intended to hold these bonds for more than three years, they can save on taxes. Long term capital gains (LTCG) are taxable at a lower interest and offer indexation benefits. On the other hand, if an investor holds PSU bonds for less than three years, the LTCG will be taxed according to income slab. To reduce huge tax amounts, investors can prefer a PSU bond with a long term maturity date. If you buy the bond at a premium and hold it till maturity, long-term capital loss (LTCL) can be set off against LTCG from any other asset.
Opportunity in present economic condition offering better yields
The ongoing yields on the PSU bonds are promising. The annual returns offered by PSU bonds can go up to 8%-10%, subject to price fluctuations in the market. Global growth is slowing down. Market interest rates may not increase in the near term. PSU Bond investment is an opportunity in such market downturns.
Retail investors can take the mutual fund route also. An individual can invest in PSU bonds through gilt mutual funds. These are the funds that further invest in government bonds. Gilt Debt Funds invest in bonds and fixed income instruments issued by the governments. Debt funds are also gaining investors because of high-rated PSU bonds in their portfolios. Before heading to the fund investing, it is necessary that you decide your financial objective to align it with the bond maturity. Investors should consider the costs involved in the fund investing, such as expense ratio and exit load. PSU focused funds carry less exit loads than credit risk funds. You can find some of these funds that do not charge any exit load.
Bonds as collateral against loans
PSU bonds are considered safe investments and can be used as collateral to borrow funds from several banks and financial institutions. The loan amount can be high as these bonds have the government back. There is less possibility of default risk. Therefore, it is easy to get loan approval against PSU bonds. However, you may search for financial institutions that add PSU bonds in their list of approved securities to provide a loan.
Easy investment without complexity
You can invest freely in PSU bonds. Unlike stocks, investors do not need much analysis of the market, interest rate movements or factors impacting market conditions. You need not worry about tracking. Simply, if the market interest rates are going down, you can consider to include bonds or bond fund units in your portfolio. Any novice investor without experience can start investing in it. However, when you pick a PSU bond, you should analyze the fund performance in both bullish and bearish runs.
A carefully built bond portfolio offers better returns at low risk. If you want to invest on your own, you can compare reputed AMCs, similar bond schemes and start investing. Otherwise, you can create a profitable bond portfolio with the help of investment advisors.