Dollar denominated bonds a preferred choice to earn extra yield overseas

MUMBAI: Rich Indians, who park money in overseas destinations for future use, have devised a new strategy to push up their return on investments.

Instead of parking their money in a bank, where they are offered near-zero interest rates, savvy Indians are investing in dollar denominated bonds of Indian companies and multiplying their exposure four-fold by leveraging on their newly-acquired bond units. This strategy results in net portfolio yields expanding to over 10%. In the process, they may be treading a regulatory twilight zone.

According to wealth managers, investors use the liberalised remittances scheme (LRS) route to send money abroad. Under LRS, resident Indians are allowed to ship out $250,000 (per person) every year.

“These are typically resident Indians who want to keep their money in overseas destination for future use – like to meet their ward’s education expenses or prospective medical costs,” said Nikhil Johri, CEO of Trivantage Capital Management, a fixed income portfolio management firm.

Resident Indians play the LRS route by actually buying bond units with the money they have sent out. These units are later used as collateral to raise four times more investible funds. The borrowed money (at 1.5-2% interest cost) is used to buy more bonds, thereby expanding the volume of bonds in the portfolio. This results in a fourfold increase in net portfolio yields (after deducting leverage cost), which could be as high as 11%.

“Money that is otherwise held in foreign banks at lower rates is now being invested in these bonds more gainfully. And there are no perceptible ambiguities here as the investor is using the LRS money to buy bonds, which is a permissible security,” Johri said.

Despite the government-imposed curbs in 2013 and 2014, resident Indians have been using the LRS route to invest abroad. Money sent through LRS route has increased from $1,206.4 million in 2012-13 to $1,325.8 million last fiscal.

Even though LRS is popular, there are grey areas with regards to the choice of instruments that resident Indians can invest in. The above strategy could well mean indulging in a sharp practice, said lawyers.

“Resident Indians are permitted to invest in dollar denominated bonds under the LRS scheme as these can be construed as permitted foreign securities.

However, such resident Indian investors are required to take prior approval from the RBI to create a pledge on such securities outside India” said Rukshad Davar, corporate - M&A partner at Majmudar & Partners, a full-service law firm.

While not many investors would be aware of the legal tangles, the ones who know are clearly misusing the ‘no-questions asked’ policy of the LRS route.

According to wealth managers, it’s not only resident Indians but also several NRIs who use this strategy to increase their portfolio yields. A significant portion of the $17.3-billion mobilised by Indian companies abroad has been subscribed by non-resident Indians (NRIs), private bankers opine. The lure, as is the case with resident Indian investors, is enhanced portfolio yields in the range of 8–10%.

“There’s a lot of comfort among NRIs to invest in Indian dollar bonds issued by top rated corporates as they know these companies very well. Many of these investor are prominent NRIs based in Middle East & South East Asian markets like Singapore and Hong Kong,” said Prateek Pant, executive director (products &services), RBS Private Banking.

The strategy is much simpler – and perfectly legal - for NRIs to execute. If an NRI wants to invest in an Indian bond, he needs to have just 25% of the desired investment. The remaining 75% is lend by banks at rates as low as 1.5 – 1.75% (libor + 0.75 - 1%). The money borrowed is invested in bonds that yield over 4% annually.

This arrangement allows investors to gain about 9% after meeting leverage cost. “The investor is able to get 4 times exposure – at a good spread without taking any currency risk,” Pant added.