Investing in corporate fixed deposits: The good, bad and ugly

There have been a lot of advancements in the field of investing especially after the entry of fintech companies. These companies are known for disrupting the existing players by either offering a new product, or something more convenient or something really innovative.

The convenience factor is so high that the entire process of onboarding an investor and investing is fully online with no paperwork whatsoever. With that being said, not only is there improvement in convenience, there is a lot of product and service innovation that has been happening in this space.

In a traditional world, an investor's first choice with respect to investing in a fixed income product is fixed deposits offered by banks. This is a fairly simple product that has been there for decades. However, with increasing financial literacy, more investors are looking for fixed income products that offer a higher return than a regular fixed deposit.

We have already discussed about Peer-To-Peer lending as an alternative fixed income product in our previous post.

In this post, we are going to talk about a very new concept of investing in alternative fixed income assets through various fintech platforms.

What is an alternative fixed income asset?

An alternative fixed income asset is a non-market linked asset that generates either regular cash flows or a lump sum benefit at maturity. These assets are very short term in nature having maturity between 30 days to 3 years. To your surprise, anything and everything in this world can be converted into such an investable asset. Let us take an example of an NBFC that has a portfolio of gold loans.

So an NBFC now has an asset that is in the form of gold loans that it has given to the borrowers against the gold. This gold is lying with the NBFC in its lockers and borrowers will be able to take it only after repaying all the EMIs of the loan.

Suppose there are 1000 borrowers with an average loan amount of Rs. 20,000. This is an asset pool of Rs. 2,00,00,000 on which the NBFC will earn an interest of let's say 15% per annum.

An alternative investment platform will take over this asset pool from NBFC at 14% per annum interest and make small chunks of it for retail investors to invest in.

Suppose a platform comes and offers a small portion of this investment at 13% per annum to retail investors who can invest as low as Rs. 1,00,000 in this asset, It becomes a win-win situation. Let's understand how this works.

• A retail investor will invest in this asset and earn 13% per annum (fixed)
• An NBFC will get back the money they have lent and can lend it again to other borrowers
• The platform will make a small commission in this deal let's say 1-2%

Any asset that has cash flows attached to it can be converted into such a deal and retail investors can invest their money and earn higher fixed return than a traditional fixed deposit.

We have just taken the gold loan as an example for explanation but this can be worked out with consumer loans, vehicle loans, credit card loans, invoice discounting, real estate project funding etc. These deals can be highly customised depending upon the requirements of investors.

Platforms like Gripinvest, Jiraaf, Wintwealth are offering such products to retail investors through their websites.

But not everything is as rosy as it seems. There are risks attached to these investments and one needs to understand the following risks before investing in such products:

Platform risk: The fintech company or the platform you have invested through is an important link between you and the other party. If the platform shuts its operations then it could pose a huge risk to investments because an investor is not equipped with the information on recovery of the money.

Investment risk: When you are dealing with such complex products, there are contracts between investor, borrower and platform but they are not as strict as that of the contracts with banks. These are typically normal agreements where multiple investors are involved. If there is a default on behalf of the borrower then it can become a tough task to recover money.

No risk for platforms: These platforms operate as intermediaries, their only job is to match the investor and borrower. They do have due diligence in place before onboarding a certain borrower but it's not as strict as the due diligence done by banks. Neither do they have strong recovery teams in case of defaults. So the ultimate risk of returning the investment does not lie with these platforms.

Unstructured approach: In some cases you will get a certain debenture into your demat account against the loan but in a lot of cases, the normal contract is the only documentary proof of investment.

Contract enforcement risk: In case of default, a single contract will have multiple investors and it would be a difficult task to take a legal recourse if there is no single borrower to file the case against the defaulter.

TIP: Alternative fixed income assets is a fresh market and is at a very nascent stage. Also the dealings are very small in nature for any default to come in public. An investor with a high risk appetite can look into these products. It is also advisable to get in touch with your financial advisor to check the suitability of such products in your portfolio.

CA Rohit J. Gyanchandani is Managing Director, Nandi Nivesh Private Limited, A Pune based Wealth Management Company.