In the current scenario, where interest rates are rising, inflation continues to be high and stock markets are full of uncertainty, your options are limited, if you want to minimise risk.
The returns on bank fixed deposits do not beat inflation. Gold and other metals are good but very volatile at the moment. While they usually don’t go down, the pace of appreciation can differ. In such a situation, non-convertible debentures (NCDs) could be an option worth considering. They offer higher interest rate than a bank FD, government bonds, or infrastructure bonds. And while they were not very popular for some time, they are now making a come back.
For example, Shriram City Union issued NCDs recently and offered an interest rate of 12 per cent. If you look at typical bank FD, the interest rate is closer to 10 per cent. The tax regime for both too is different. A convertible debenture is a bond or debt certificate that can be converted to equity after a pre-determined period. An NCD on the other hand is a regular bond that cannot be converted into equity.
Since convertible debentures have the option to be converted into equities, they offer less interest rate. NCDs offer a higher interest rate. Not surprisingly, they are catching on in popularity. NCDs can be secured or non-secured. Secured NCDs are less risky because they are secured against the collateral by the company assets. If the company is not able to service its obligation, the company assets are sold to pay back the NCD holders. Unsecured NCDs are riskier because they are not backed by any collateral. Unsecured NCDs naturally offer a higher interest rate than the secured ones.
Features of NCDs?
The tenure of NCDs varies from two years to 20 years and they are very flexible. Unlike bank FDs, you don’t have to retain it for a number of years to claim the interest rate because they can be bought and sold in the secondary market at will.
The tax regime on NCDs is simple. If you sell it before a year, you pay the tax according to the bracket you fall into. If you sell it after a year, you pay tax at 10 per cent or at 20 per cent depending on whether you apply indexation.
Typically, NCDs offers better interest rates than bank FDs. Bank rate depends on the policy rate revised by RBI. If the RBI further raises policy rates and bank increase their interest rate, the returns may not be very attractive from NCDs.
Risks factors
But these bonds may sound attractive and even secure, especially if it is a good company, there are some risks investors have to know. NCDs are relatively safer but certainly less safe than bank FDs and government bonds.
Banks normally never default as the Reserve Bank of India will come to the rescue if most of the times. Governments also never default. The NCD issuer may default, if the company faces problems in paying the obligation to the bond holders.
Key points
Non-convertible debentures (NCDs) are supposed to get rating from rating agencies such as ICRA and CRISIL. Investors must check the rating of NCDs before investing. Higher rating implies that the company has enough resources to service its debt obligation.
Liquidity is another issue. Despite their plus points, NCDs are not very popular instruments and hence investors may find it difficult to sell then when they want to. If there are not enough buyers, investors may have to sell them at lower price which will impact the returns.
Finally, if the interest rates go up, the NCD will go down in value. While in case of FDs, investors can break the existing deposits and open a new one with higher interest, the same is not so easy in the case of NCD. Disposing NCDs is difficult because of low liquidity in the market.
(The writer is the CEO of bankbazaar.com)