Investing in G-Secs (or government securities) is ultra-safe for investors with low-risk appetite- both retail as well as institutional.
Within this category, some financial innovations keep occurring from time to time to woo the investors. One of the recent phenomenon that have yet to catch the investors' fancy is known as G-Sec STRIPS.
They are created out of existing securities only and unlike other securities, are not issued through auctions.
What is a strip?
A strip is a bond coupon which has been removed from the bond for selling the two parts separately: interest-paying coupon bond as well as zero-coupon bond.
In other words, this refers to the separate trading of interest and principal securities.
Let us understand this with the help of an example. When ₹100 of the 8.60 percent GS 2028 is stripped, each coupon cash flow ( ₹4.30 each half year) will become a coupon STRIP. At the same time, the principal payment (of ₹100 at maturity) will become a principal STRIP.
These cash flows are then traded separately as independent securities in the secondary market.
It is vital to understand that the stripping does not alter the cost of borrowing or the timing of the underlying cash flows. It only enables the transferring the right to ownership of individual cash flows.
For retail investors
Being zero coupon bonds, STRIPS have zero reinvestment risk and they are attractive to retail investors as well. Market participants with an SGL account with RBI can place requests directly in e-kuber for stripping of eligible securities, states the RBI portal here.
Requests for stripping by Gilt Account Holders (GAH) will then be placed with the respective custodian maintaining the CSGL account, who in turn, will place the requests on behalf of its constituents in e-kuber.
Some financial planners recommend STRIPS as an alternative to the fixed deposits of banks to earn more.
Vikram Dalal, founder, Synergee Capital, says that STRIPS offer nearly 100-150 basis points higher than what bank deposits offer to investors.
What are the advantages?
These are essentially meant for the low-risk investors such as pension funds and insurance companies. They also offer much greater leverage to hedge funds, since the zero-coupon bonds are more volatile than the underlying coupon bearing bonds.
STRIPS enable the availability of zero-coupon bonds (ZCBs) to the investors and traders. They give the most basic cash flow structure thus offering the advantage of more accurate matching of liabilities without reinvestment risk and a precise management of cash flows.
STRIPS offer excellent investment choices to some investors who set the incoming inflows against an actuarial book, for example, insurance companies, says an RBI report.
Due to the differing interests of multiple segments of investors in the market, demand for each component of the STRIPS may be so high that the sum of the values of the constituent parts can exceed the value of the whole bond, the report says.