Decoding the new way to invest in G-secs

Are you a retail investor who has been feeling the lack of long-term options to park your safe debt money? Then you may see opportunity in the new avenues being opened up to grant options to retail folk to invest in government bonds.

Having opened an account to participate in government securities through your stock broker NSE goBID or the latest Retail Direct platform from the RBI, how should you participate in the market?

We demystify the world of government bonds.

What’s on the menu

Just like in the stock market, the market for government bonds is categorised into the primary and secondary segments. Unlike varied company promoters who sell shares through IPOs, there’s only one authorised seller for new issues of government bonds — the Reserve Bank of India. The RBI conducts periodic auctions of government securities in which institutions such as banks, insurance companies and provident funds participate. Retail investors can buy G-secs in these auctions through non-competitive bids under a special quota, subject to a minimum of ₹10,000 and a maximum of ₹2 crore.

The key instruments available are Government of India Treasury Bills (T-bills), Government of India dated securities (G-secs), Sovereign Gold Bonds (SGBs) and State Development Loans (SDLs). T-bills are issued when the Central government wishes to borrow for 91-day, 182-day and 364-day periods. Dated G-secs and SDLs are issued for tenures from 1 to 40 years.

How primary auctions work

Unlike IPOs, which may pop up anytime, RBI’s primary auctions stick to a specific calendar, so you can plan your purchases well in advance. For dated G-secs, RBI publishes its auction calendar six months ahead here: https://tinyurl.com/rbigsecs You can find its quarterly calendar for T-bill auctions here: https://tinyurl.com/rbitbills

Once you log on to your G-sec trading platform, you are presented with a list of government securities currently being auctioned.

T-bills are offered at a discount to their face value which represents the return you get. If a 182-day T-bill with a face value of ₹100 is offered at ₹98, your yield on it is 4.09 per cent (2/98 * 365/182). But auctions of G-secs may be yield-based or price-based. New G-secs are generally issued through yield-based auctions, where investors bid based on the coupon rate that they’d like to demand from the government. The lowest coupon at which an auction gets fully subscribed is taken as the cut-off yield and becomes the interest rate on the bond. The RBI also conducts price-based auctions when it re-issues older G-secs. In competitive bidding, all institutions who bid below the cut-off yield or above the cut-off price bag allotments.

As a retail investor, you are required to bid at cut-off yields/prices decided by institutions and will be allotted bonds at the weighted average price that emerges from competitive bidding.

If the weighted average price is higher than the cut-off rate, then you may have to shell out slightly more than the face value to acquire your G-secs, which is collected as the excess mark-up.

Nuts and bolts of Retail Direct Gilt account

Secondary market trades

CCIL’s Negotiated Dealing System Order Matching or NDS-OM is the platform on which secondary market trading in government bonds takes place. Even telephone trades are captured here. This is, therefore, the platform you need to log on to for information on the latest market action, prices and liquidity in government bonds.

The NDS-OM offers two segments — a Regular Market and Odd Lots segment. As the minimum lot size for trading in the Regular Market is ₹5 crore, it is the Odd Lots segment (trades below ₹5 crore) that is key for retail investors looking to dabble in G-secs.

Just as you can track live market quotes for stocks you’re looking to buy on BSE or NSE, you can track live market quotes for G-secs, T-bills and SDLs on NDS-OM during market hours here: https://tinyurl.com/ccilindia

To buy and sell securities, you’ll first need to understand the nomenclature used. Central government bonds are described using their coupon rate and maturity year. The current 10-year Central government bond is described as 0610GS2031 — 6.10 per cent is the coupon rate and 2031 is the maturity year. While fixed rate bonds are described using their coupon rates, floating rate bonds are described simply as FRBs. T-bills follow a slightly different nomenclature, with their tenor (and not coupon) featuring in their description. So, 091DTB17022022 is the 91-day treasury bill maturing on February 17, 2022. Descriptions for SDLs carry additional information on the States issuing them.

The NDS-OM home page lists all the securities traded for the day, with the open/high/low, last traded price (LTP) and last traded yield (LTY), along with individual order books. Securities that are actively traded in the regular market may not trade on odd lots and prices and yields may vary between the two.

What to consider

When choosing which government bonds to invest in, three factors need to go into the decision.

1Tenure

The tenure or maturity period is a big influence on the returns you make from a bond. So, how do you decide whether to buy a 91-day T-bill or a 20-year G-sec? Well, you can base this decision on three variables.

One, you can simply match the tenure of the bond to your financial goal. If you’re looking to save towards expenses planned in 3 months’ time, a 91-day T-bill will suit you. If you’re looking to park money towards retirement, a 20-year G-sec may fit the bill.

Two, your choice should depend on whether you expect market interest rates to move up or down from here. When interest rates move up, prices of older bonds can fall as buyers rush to buy newer bonds with better coupons. The longer the tenure of a bond, the more sensitive it is to rate upmoves. Interest rates, like the Sensex, move in cycles. To gauge if market interest rates are at a low or a high, it is useful to refer to historical trends in RBI’s repo rate and the market yield of the 10-year government bond.

In the last 20 years, RBI repo rates have demonstrated a range of 4 per cent to 8 per cent, and the 10-year G-sec has swung between 5.8 per cent and 9.1 per cent. Today, with the repo rate at 4 per cent and the 10-year G-sec at a yield of 6.3 per cent, we are clearly closer to the bottom end of this range. This makes shorter bonds more attractive than long-term ones.

Three, you can consider the shape of the yield curve to decide on tenure. Usually, stretching your bond tenure entails higher risk (as rates may move up and the buyer may default). Therefore, it makes sense to prefer, say, a 20-year bond over a 10-year one only if the former offers a much higher yield than the latter. Today, for instance, while a 364-day T-bill offers a yield of 4.03 per cent, the 3-year G-sec offers 5.09 per cent, the 5-year G-sec 5.68 per cent and the 10-year G-sec 6.36 per cent. Essentially while you earn 106 basis points more in interest by opting for a 3-year tenure instead of 1-year, there’s only a 59-basis point benefit in stretching your tenure from 3 to 5 years. To minimise risk, you may prefer the 3-year.

2 Type of bond

While there’s not much to choose between a T-bill and a G-sec as both are issued by the Centre, you need to be more choosy while opting for SDLs. SDLs are typically priced based on the financials of the State that is issuing them, after factoring in variables like its latest fiscal and revenue deficit position, its ability to raise tax revenues and its borrowing plans. If you aren’t confident of putting in this homework, the mutual fund route to participating in SDLs is better.

3 Liquidity check

Unlike shares, government bonds in India do not carry high secondary market liquidity, especially for investors in the Odd Lots segment. Whilst buying government bonds, therefore, it pays to be prepared to hold till maturity (which also helps avoid rate risk). In case you plan to exit early, you must check out the number of trades and total traded amount of the bond on NDS-OM. Typically, the most recently issued 10-year, 5-year and 3-year G-secs corner over 70-80 per cent of the trades by volume and value. T-bills and SDLs register far lower trading volumes than long-tenor G-secs. Time decay may reduce liquidity too. You can find a list of all outstanding government bonds whether traded or not, here: https://tinyurl.com/govtbonds. Bonds with a higher outstanding quantity are likely to be more liquid.