Nonconvertible Debentures: Here's what every investor should know about them

There are several reasons that make nonconvertible debentures a good investment choice. But are they suitable for you?

Nonconvertible Debentures: Here's what every investor should know about them

Capital markets can be notoriously fickle. Many Indians feel that investing in capital markets is like a lottery, and is one of the reasons why most Indians are not comfortable investing in equity. Instead, they want the security of assured and steady returns; which is why Non-Convertible Debentures (NCDs) are currently drawing most people’s attention.

The case for investing in NCDs

Are decent returns, moderate risk and easy liquidity vital to you? Then NCDs make a suitable investment instrument.

NCDs are fixed-income debt instruments that are often used by corporates to raise money for business purposes. Companies issue such NCDs for a specified time and agree to pay a fixed rate of interest to investors.

Features of NCD

Payouts: Most NCDs offer an annualised or cumulative payouts, but there are some that could also provide half-yearly or monthly payouts. If, as an investor, you hold an NCD until maturity, the interest you earn on it will be added to your total income. However, you will have to pay tax on this amount, depending on the tax slab to which you belong. You can invest in NCDs in two ways.

  • During the public issue of such bonds
  • Or through the secondary market. This option is possible as NCDs are listed on the Bombay Stock Exchange (BSE) and the National Stock Exchange of India (NSE).

Secured or unsecured: You can choose from either secured and unsecured NCDs, based on your preferences.

  • Secured NCDs – Have the backing of assets. This is useful if the company issuing it is unable to fulfil its obligation to investors. In this situation, the company liquidates these assets to pay its investors.
  • Unsecured NCDs – Do not have such asset backing. For this reason, they offer a higher coupon rate (interest rate offered by the NCD issuer) than what secured NCDs offer.

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NCDs may also come with a call or put option. A company that issues a callable NCD can redeem or ‘call’ the bond before maturity. For example, the company issues a callable bond in a high-interest regime. It can later decide to exercise the call option when the interest rates fall.

A put option works in the opposite manner. An investor can sell the NCD at a specified price if interest rates spike after the issue of the debentures.

How to choose the right NCD

There are several important factors that you must consider before investing in an NCD. These include:

  • Credit rating: The coupon rate (interest rate offering) may seem attractive on an NCD. But you must also take note of the credit rating. This is a third-party assessment of the credit risk that the instrument carries. The lower the rating, the higher will be the interest rate offering on the NCD.
  • Issuer’s credibility: The credibility and the track record of the issuer offering the NCD are also important.
  • Aim behind the fund issue: As mentioned previously, companies issue NCD with an aim to raise capital. But, you need to know why they require additional fund. Is it for further expansion or are they using it to repay their debt?

Related: ETFs: 6 Reasons they make an excellent instrument for investors

Pros and cons of investing in NCDs

 

Pros:

  • NCDs come with a limited lock-in period and are listed on the stock exchange
  • They also offer liquidity despite being debt instruments.
  • The tenures range from two to 20 years. This makes it possible to tie your NCD investments with various financial goals.

Cons:

  • NCDs also carry a default risk.
  • Additionally, lack of a vibrant secondary market is a disadvantage. You may end up selling the NCD at a discount.


Related: Simple ways in which you can diversify your financial portfolio

It is for this reason that financial investors advise caution when investing in this type of instrument. In fact, given their risk profile, NCDs should not make up more than 20% of your total investment portfolio.

Disclaimer: This article is intended for general information purposes only and should not be construed as investment or tax or legal advice. You should separately obtain independent advice when making decisions in these areas.

 

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