Every investor wishes to have investments which offer high returns and also manage liquidity and risk. A Non-Convertible Debenture (NCD) is one such investment. It delivers higher returns as compared to fixed deposits after liquidity. Traditional investment options such as Fixed Deposits or PPF can offer steady income but the returns may turn out to be low. Hence NCD is another avenue which investors are exploring.
What are Non-Convertible Debentures?
Whenever a company wants to raise money from the public it issues a debt paper for a specified tenure where it pays a fixed interest on the investment. This paper is known as a debenture. Some of the debentures are termed as convertible debentures since they can be converted into equity share on maturity. A Non – Convertible debenture or NCD do not have the option of conversion into shares and on maturity the principal amount along with accumulated interest is paid to the holder of the instrument.
There are two types of NCDs-secured and unsecured. A secured NCD is backed by the assets of the company and if it fails to pay the obligation, the investor holding the debenture can claim it through liquidation of these assets. Contrary to this there is no backing in unsecured NCDs if company defaults. However, any company seeking to raise money through NCD has to get its issue rated by agencies such as CRISIL, ICRA, CARE and Fitch Ratings. A higher ratings (e.g. CRISIL AAA or AA-Stable) means the issuer has the ability to service its debt on time and carries lower default risk. A lower rating signifies a higher credit risk.
Interest Rates in Non-Convertible Debentures
In high interest rate scenario, NCDs offer high rates to investors. The average rates in last few years have been 11-12%. Most of these were secured NCDs. Also, companies which carry higher risk give more than others to lure investors for investment. There can be various options for interest payout such as monthly, quarterly, half yearly or annually. However, most NCDs offer annual and cumulative payout. Investors wish to earn higher returns opt for cumulative option where the interest is reinvested and paid at maturity.
Risk involved
NCDs have some inherent risk associated which an investor has to take into consideration before making any investment decision. The biggest risk is the credit risk. The company can default on the future payment and if it is unsecured NCD, an investor does not have any recourse. Most companies get rating through agencies like CRISIL or CARE based on various parameters which investors can check for credibility. A rating of AAA by CRISIL is considered to be highest on safety. The second risk is the liquidity risk. Even if NCD get listed, low volumes (case of low rated NCDs) can deprive investors of any opportunity in exiting prematurely.
I would like to share a few tips and factors that you should keep in mind while investing in NCDs and how should you choose the best NCD.
Check the Coupon rate
A Coupon is basically the interest rate offered by the issuer. NCDs have a comparatively higher interest returns than FDs. It is generally around 11%. This is one of the main reasons why investors are turning towards NCDs.
Look at the tenure offered
After the Coupon Rate, the tenure is the next thing you should look at. Issuers offer different tenure options depending on their NCD issue. Based on your requirements you can choose a tenure. Instruments with longer tenure are sensitive to changes in interest rates.
Frequency for payment
The usual range for payment of NCDs is monthly, quarterly or yearly. You need to choose which time range suits you best as per your needs.
Credit Ratings
A Credit rating is a perfect way to assess the issuer’s credit performance. These ratings are an indicator of how well and how timely can the company repay the obligation. The rating is generated by agencies such as CRISIL, CARE, Brick Works, or ICRA. Ratings AA or above are generally considered as ‘good’ for investments.
Yield to Maturity
This is the annual return which investors earn on the NCD investment if held until maturity. When you invest in an NCD you need to look at the Yield to maturity amount and coupon rates. This will help you decide if investing in a particular NCD is worth it or not. NCDs can help investors reach their financial goals smoothly.
Hope this article gives you another option to park your surplus funds, however as I mentioned above do your necessary due diligence before taking a positive step in its direction.
