Bond investing: Key risks you should know before putting in money

Bonds are often seen as a relatively stable investment because they offer a defined interest payment, but they are not risk-free. Investors can face losses if an issuer defaults, bond prices fall before maturity or they are unable to sell their holdings at a reasonable price.

Understanding these risks is important before investing, particularly in corporate bonds that offer higher yields than government securities.

Credit risk: Can the issuer repay?

Credit risk is the possibility that an issuer may fail to pay interest or repay the principal on time. In severe cases, investors could lose part or all of their invested capital.

Nishchay Nath, Founder and CEO of BondScanner, a SEBI-registered Online Bond Platform Provider, said a credit rating is an agency’s opinion of an issuer’s ability to repay, not a guarantee. Investors should also examine whether a bond is secured and understand the terms of that security.

Ashish Thekkekara, Co-founder and Managing Director of Capital Stack, an Indian financial services company and neo-investment bank, said investors should look beyond the headline yield and assess the issuer’s financial health, cash flows, debt levels and repayment capacity.

A higher yield may reflect higher credit risk rather than an attractive opportunity. Investors should therefore understand why a bond offers a substantially higher return than comparable securities before committing money.

Interest rate risk: Bond prices can fall

Bond prices generally move inversely to market interest rates. When rates rise, existing bonds with lower coupon rates may become less attractive, pushing their market prices down.

This matters particularly to investors who need to sell before maturity. The longer the bond’s duration, the more sensitive its price tends to be to interest rate changes.

Mohit Gupta, Co-founder, CTO and CPO of EquiRize Securities, an Indian financial technology and fixed-income investment platform, said the longer the tenure, the sharper the potential price movement when interest rates change. Matching a bond’s maturity to when the money is needed can help investors manage this risk.

Investors who hold a bond to maturity can avoid realising an interim market-price loss, provided the issuer meets its repayment obligations. However, holding to maturity does not eliminate the risk of default.

Liquidity risk: Exiting may be difficult

Unlike equities, some corporate bonds trade infrequently in the secondary market. Investors looking to sell before maturity may struggle to find a buyer or have to accept a lower price.

Nath said secondary-market trading in many corporate bonds remains thin, meaning an exit at a fair price is not guaranteed.

Liquidity risk is particularly relevant for investors who may need access to their money at short notice. Before investing, they should consider their financial requirements and avoid locking away money that may be needed before the bond matures.

Reinvestment risk: Future returns may be lower

Reinvestment risk arises when interest payments or principal repayments have to be invested again at lower prevailing rates.

For instance, if an investor receives a coupon when interest rates have fallen, the money may earn a lower return when reinvested. The same applies when a bond matures and the principal has to be deployed into another investment.

Gupta identified reinvestment risk as another factor investors should consider, particularly when assessing the income they can expect over the life of a bond.

Concentration risk: Avoid excessive exposure to one issuer

Investing a large share of a portfolio in a single issuer, sector or type of bond can magnify losses if that issuer faces financial stress.

Thekkekara said diversification across issuers, sectors, maturities and credit profiles can help reduce the impact of an individual credit event.

Investors should assess their overall fixed-income exposure rather than evaluate each bond in isolation. Diversification can reduce concentration risk, although it cannot eliminate market or credit risk.

Operational risk: Check the platform and transaction details

Investors should also understand how a bond is held and how the transaction is executed, including the role of the intermediary, the demat account in which the security will be held and the counterparty involved.

Gupta flagged process risk as an often-overlooked aspect of bond investing and advised investors to check whether the platform is registered with SEBI, where applicable.

Investors should verify the platform’s regulatory status, review the offer document and contractual terms, and understand the transaction and settlement process before investing.

What should investors check before buying bonds?

Saurabh Saraswat, Managing Partner and Fund Manager at Inquant, an India-based quantitative investment and asset management firm, said bonds can help diversify portfolios, but investors should distinguish between government and corporate securities.

Indian government bonds denominated in rupees generally carry very low credit risk, but they remain exposed to interest rate risk. Corporate bonds can carry both credit and interest rate risks, with the level of risk varying by issuer and instrument.