Debentures as a Wealth Strategy: Insights from Sri Lankan Experts

A recent webinar organized by Corporate Capital Market Ltd. shed light on the role of debentures in diversifying investment portfolios, providing steady income, and protecting against inflation. The session featured industry experts, including Colombo Stock Exchange (CSE) CEO Designate Vindhya Jayasekera, NDB Investment Bank Chief Operating Officer Kaushini Laksumanage, and Nestor Stockbrokers Managing Director Nandun Jayatillake. The presenters outlined the features of different types of debentures available in Sri Lanka, their advantages, and the practical steps for investors to participate in the market.

Key Takeaways:

• Debentures function as long-term loans raised by companies through the capital market, with investors becoming creditors entitled to periodic interest (coupons) until maturity. Unlike shareholders, debenture holders have no ownership rights but enjoy priority claims in the event of liquidation.
• A comparison between fixed deposits and debentures illustrates the advantages of debentures. A five-year deposit at 10% yields an effective annual return of 8.45% if left untouched, while a comparable debenture paying semi-annual coupons allows investors to reinvest interim cash flows, producing higher overall returns.
• Debentures listed on the CSE provide investors with the option to trade in the secondary market, although volumes remain low. They also carry minimum investment thresholds, generally Rs. 10,000, with higher minimums for Basel III-compliant instruments that banks issue to meet regulatory capital requirements.
• Investors, Jayasekera emphasized, must research issuers before committing, as debentures, though safer than equities, still carry credit risk.
• The range of debentures available in the market includes terms from two years to as long as fifteen years, with perpetual debentures carrying no redemption date but offering only coupon payments. Instruments may be senior or subordinated, and convertible debentures can be converted into equity under certain conditions.
• The CSE provides transparency by enforcing listing rules and disseminating information. The Securities and Exchange Commission oversees compliance with disclosure requirements and monitors for misconduct.
• Credit ratings remain a primary signal of repayment ability, with most investment-grade debentures in Sri Lanka falling between AAA and BBB. Instruments rated below BBB carry higher coupons but greater risk, requiring investors to weigh creditworthiness against potential returns.
• The Central Depository System (CDS) maintains electronic records of ownership and facilitates coupon and principal payments directly to investor accounts. Settlements take place on a T+1 or T+2 basis, ensuring transparency and security.
• Investors can enter the debenture market by opening a CDS account through a licensed stockbroker, either via mobile app or in person. Applications for debentures during primary issues are lodged through brokers, and allotted securities are credited directly to the CDS account.
• Secondary trading gives investors flexibility, allowing them to sell debentures at a premium or generate capital gains if market interest rates fall. The CSE provides a normal board, a crossing board for larger trades, and an over-the-counter for high-yield bonds.

Statistics:

• Average deposit rate over the past two decades: 8%
• Average inflation rate over the past two decades: 9%
• Effective annual return of a five-year deposit at 10%: 8.45%
• Typical minimum investment threshold for debentures: Rs. 10,000
• Higher minimums for Basel III-compliant instruments: Rs. 50,000 or more
• Time period for PERPS: typically between 2 years to 15 years
• Total CSE debenture market: around 5 lac
• Volume of debentures listed on the CSE: remains low

Sources:

• Corporate Capital Market Ltd. (webinar on 'Debentures as a wealth strategy')
• Colombo Stock Exchange (CSE)
• NDB Investment Bank
• Nestor Stockbrokers
• Securities and Exchange Commission (SEC)
• Central Bank of Sri Lanka
• Wijeya Newspapers Limited (Copyright 2022)