Non-convertible debentures or NCDs are popular financial instruments that you can consider investing in. These are offered by companies to raise money from the public. As the name suggests, these debentures cannot be converted into equity shares of the company — they are debt instruments that can aid in long-term capital appreciation.
Here’s what you need to know about the key features of NCDs and the benefits of investing in them:
- NCDs have a fixed maturity. Depending on the terms of the issue, the issuer can pay the interest and the principal on a monthly, quarterly, or annually basis.
- There are two categories of NCDs:
- Unsecured NCDs: Such NCDs are not secured by any issuer’s assets. Although they offer a better rate of interest compared to their secured counterparts, they are risky to invest in. A potential investor has to solely rely on the credit rating to know the creditworthiness of the issuer and the chances of payment default.
- Secured NCDs: These NCDs are secured by the assets of the issuing company. They are considered safer than unsecured NCDs even though such instruments offer a lower interest rate. If the issuer makes any default in making payments to the investors, assets can be liquidated to recover the dues.
- The high liquidity of NCDs makes them a sought-after investment option. They can be both listed and unlisted. You can sell them in the secondary market to encash them.
- Different maturity timelines, ranging from 90 days to 20 years, make NCDs attractive to investors as they can choose one depending on their needs and risk profile.
- The interest rate of NCDs is another feature that stands out. On average, NCDs offer interest payout in the range of 7% to 9% which is higher than what savings account offers. The interest rate of NCDs issued by NBFCs is usually 150-175 bps higher than what fixed deposits with scheduled commercial banks in India offer. That’s why NCDs are a great option if you want to lock in your investment for a longer period of time.
- NCDs are closely regulated by the Reserve Bank of India. Every issuer has to follow a stringent compliance checklist before offering these instruments in the market. Furthermore, the Companies Act also requires every issuer to comply with post-issuance formalities.
- NCDs are taxable investments. The amount of tax payable depends on the tax bracket to which the investor belongs. NCDs that are sold within one year of issue attract STCG. When sold after a year or prior to the maturity date, they also attract LTCG at 20% with indexation.
The interest from NCDs is also taxed as fixed income securities under ‘income from other sources.’ However, no TDS is applicable on NCDs issued in DEMAT form and listed on a stock exchange.
- The rating of NCDs is an important factor to consider if you want to invest. Every issuer offering NCDs in the Indian market has to get the issue rated by credit rating agencies such as Fitch Ratings, CRISIL, ICRA, and CARE. The rating is provided on the basis of the company’s ability to service its debt obligation. It also helps the investors to judge the quality of the issue — NCDs that are rated AAA are the safest which indicates that the chances of the issuer defaulting on repaying the interest are minimal.
As a rule of thumb, the lower the rating, the higher the credit risk, and that’s why you shouldn’t invest in NCDs that are rated below AA/AA+. However, be aware that ratings only indicate the financial position when the rating is conducted. So any changes in the financial position of the issuer subsequently can affect the rating.
To sum up, the benefits of investing in NCDs are:
- You can get a better rate of interest compared to fixed deposits and savings account
- You can sell listed NCDs in the secondary market when you need to liquidate for an emergency
- You can take advantage of the capital appreciation of listed NCDs and sell them at a higher price
- The issue of NCDs is regulated in the market
Want to buy NCDs?
You need a Demat account with a brokerage firm to invest and trade in NCDs.You can also make investments in NCDs through the issuer’s website. The ASBA Forms need to be completed and submitted to Registered Broker to initiate the purchase process. NCDs listed on stock exchanges can also be bought from the secondary market.
However, before you decide on investing, make sure that you are aware of the risk factors highlighted in the information memorandum or prospectus of the issue. This will not only tell you the risks but also help you choose the right option that is suited to your risk profile. Simply going ahead with NCDs that offer a high rate of interest is not the smart way of investing. Lastly, since corporates across industries issue NCDs, it is a good idea to keep your portfolio diversified, which can also help minimize the risks.
Feeling overwhelmed by the options available in the market? Reach out to our advisors at Moneyfront, who can help you make the right investment decision. Always remember that there are no guaranteed returns from any investments, and being cautious can go a long way in safeguarding your hard-earned money.