NCDs offer attractive yields; know risks before investing

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Conservative investors do not have many options to choose from when it comes to high-yield investments. One such option with a fairly decent safety aspect is secured non-convertible debentures (NCDs) which can also give you regular income.

NCDs are issued by corporates for specified tenure to raise resources / funds from the public for long-term projects. Unlike convertible debentures, NCDs cannot be converted into equity. It is a fixed income instrument — same as bank fixed deposit or corporate deposit – that can be traded on stock exchanges. Interest income can be earned monthly, quarterly or annually or can be cumulative. On maturity, the principal amount is paid to the investor.

The interest rates on NCDs are higher than what one earns on bank fixed deposits. Currently, two NCDs are going on:

Edelweiss Financial Services has issued eight series of NCDs, carrying fixed rates of interest in the range of 8.75-9.7%, payable on tenures of 36 months, 60 months and 120 months. The company plans to raise Rs 200 crore with a greenshoe option of another Rs 200 crore. The issue closes on September 6.

Gold loan non-banking financial company (NBFC) Muthoottu Mini Financiers has launched NCDs, offering an effective annualised yield of up to 10.47%. The NCD issue will close on 9 September. The company plans to raise Rs 125 crore with an option to retain oversubscription up to Rs 125 crore, aggregating up to Rs 250 crore. The company says the secured NCD portion is up to Rs 200 crore and the unsecured NCD portion is up to Rs 50 crore.

Should you invest in NCDs?

While NCDs do give you attractive yields, there are chances of default on your payments. All NCDs come with a credit rating by rating agencies. However, this alone doesn’t guarantee safety. “We need to back NCDs issued by high-quality NBFCs and corporates to ensure minimal risk of default. The lending model, operations and governance should be best in class. I’d advise investors to look beyond the credit rating and check the fundamentals of the company themselves,” cautions Aditya Damani Founder Credit Fair.

Take a look at the interest rate scenario as well. Damani says since NCDs give fixed returns, an investor could see an erosion in the price of the NCD if interest rates rise. “In the current environment of rising inflation, it is expected that interest rates will start rising and investors should be careful,” he says.

Liquidity and taxation

Another challenge with NCDs is your money will not have enough liquidity. Even though NCDs are listed on stock exchanges, there may not be enough buyers when you want to sell your NCDs. “Many NCDs see minimal trading volumes and could be difficult to sell in times of emergency,” he says.

Besides, NCDs are taxed as per the slab rate. People in the highest slab rate must compute their post-tax return instead of focussing only on interest rates.

NCDs vs corporate FDs

Corporate FDs differ from FDs on two counts – safety and liquidity. Corporate FDs are unsecured. It means in case of a default, you risk losing money. In case of secured NCDs, however, the company will have to sell the benchmarked assets to make payments to the investors. Corporate FDs are illiquid in the sense you will have to pay a penalty if you wish to redeem your investments. Listed NCDs are listed on stock exchanges, hence give you more liquidity.

“The most important point to focus on is the issuer of the FD or NCD. In case two issuers are of similar calibre then an NCD should be better since it would usually be secured and more liquid,” says he.

Giving his final verdict, Damani advises investing in shorter tenure NCDs. “Prefer investing in Corporates/NBFCs (up to 3 years) and for longer tenure investments invest in Government backed debt because in case of NCD it is difficult to forecast which companies will be able to maintain a good track record and remain profitable in the long term,” he says.