Debenture Investment Guide For Indians: A Secure Option

Non-convertible debentures (NCDs) are a type of fixed-income investment product that offers a high-return, high-liquidity, low-risk opportunity with tax benefits. They are a type of debt instrument, similar to bonds, that are issued by companies to raise capital. NCDs offer a fixed interest rate on investments and cannot be converted into equity upon maturity. They are available in the primary and secondary markets, with varying tenures and interest payment options. When investing in NCDs, it is important to consider factors such as credit rating, liquidity, tax implications, portfolio diversification, and the financial health of the issuing company. NCDs can be secured or unsecured, with secured NCDs backed by the company's assets providing an additional layer of protection for investors.

Non-convertible debentures (NCDs)

NCDs, unlike convertible debentures, cannot be converted into equity upon maturity. They are available in two forms: secured and unsecured. Secured NCDs are backed by the company's assets, providing protection for investors even if the company defaults. In the event of a default, investors can claim their investment through the liquidation of the company's assets. Unsecured NCDs, on the other hand, do not have this asset backup, and investors may have to wait until the company repays the full principal amount. To compensate for the higher risk, unsecured NCDs typically offer higher interest rates compared to secured NCDs.

When investing in NCDs, it is important to consider the company's credit rating, liquidity, and tax implications. Credit ratings indicate the likelihood of the company defaulting on interest and principal payments, with AAA being the highest rating. NCDs can be purchased in the primary market through open issues or in the secondary market from stock exchanges like the NSE or BSE.

NCDs offer dual earning potential, with both growth-based and interest-based returns. They also provide flexibility in terms of tenure, allowing investors to choose between short and long investment periods. The interest on NCDs can be paid out at regular intervals or accumulated and paid at maturity. Additionally, NCDs are listed on major stock exchanges, providing greater liquidity and the ability to trade.

Overall, NCDs are a popular investment choice in India due to their high returns, liquidity, low risk, and higher interest rates compared to other fixed-income instruments. They offer a predictable investment option with stable returns, making them a viable alternative for debt allocation.

NCDs vs convertible debentures

Non-convertible debentures (NCDs) are fixed-income products that offer a fixed interest rate on investments. They are usually issued by high-rated companies in the form of a public issue to accumulate long-term capital appreciation. NCDs cannot be converted into equity or stocks and have a fixed maturity date. The interest can be paid along with the principal amount either monthly, quarterly, or annually depending on the fixed tenure specified.

Convertible debentures, on the other hand, can be converted into equity on maturity. They are also debt instruments, like bonds, but with the added benefit of potential equity participation. Convertible debentures are often seen as a lower-risk investment than pure equity because they have a fixed maturity date and a fixed interest rate.

When comparing NCDs vs convertible debentures, it's important to consider the following:

• Risk and return: NCDs are considered lower risk than convertible debentures because they offer a fixed interest rate and cannot be converted into equity. NCDs also offer higher returns than convertible debentures, making them attractive to investors seeking high-return, high-liquidity, and low-risk investments.
• Tax benefits: NCDs offer tax benefits that may not be available with convertible debentures. NCDs are taxed as per the income tax slab rate, and if held till maturity, they can offer a high-interest rate ranging from 7% to 9%.
• Liquidity: NCDs are listed on the stock market and can be sold in the secondary market, providing liquidity to investors. However, NCDs cannot be withdrawn before maturity, while convertible debentures may offer more flexibility in this regard.
• Credit rating: NCDs can only be issued by companies with good credit ratings, as specified by the RBI. A higher credit rating indicates a lower default risk and is an important parameter to consider when investing in NCDs.
• Investment objectives: NCDs are suitable for investors seeking fixed-income investments with a long-term horizon. Convertible debentures, on the other hand, may be more suitable for investors seeking potential equity participation while also enjoying the benefits of a fixed-income product.

Secured vs unsecured NCDs

Non-convertible debentures (NCDs) are a type of long-term debt security issued by companies with a fixed interest rate for the duration of the investment. They are a way for companies to borrow funds from the public or institutional investors, with the promise to repay the principal amount along with interest at predetermined intervals.

NCDs can be classified into two types: secured and unsecured NCDs. Here's a detailed comparison between the two:

Secured NCDs

Secured NCDs are considered less risky compared to unsecured NCDs. They are backed by specific assets of the company, such as properties, plants, and machinery. In the event of a default by the issuing company, investors holding secured NCDs can claim their investment through the liquidation of the company's assets. This added layer of security makes secured NCDs attractive to investors who prioritise lower risk. The interest rates offered on secured NCDs may be slightly lower than those on unsecured NCDs due to the reduced risk.

Unsecured NCDs

Unsecured NCDs, on the other hand, do not have any company assets pledged as collateral. Investors in unsecured NCDs rely solely on the creditworthiness and repayment capacity of the issuing company. The absence of collateral makes unsecured NCDs riskier than their secured counterparts. To compensate for the increased risk, unsecured NCDs generally offer higher interest rates. Investors seeking potentially higher returns may be drawn to unsecured NCDs, but they should be mindful of the higher risk involved. Credit rating assessments become crucial for investors in unsecured NCDs, as the financial health and creditworthiness of the issuing company are vital factors.

The choice between secured and unsecured NCDs ultimately depends on an investor's risk tolerance, return expectations, and their desired level of security. It is essential for investors to conduct thorough due diligence, including assessing the credit rating and financial stability of the issuing company, before making investment decisions in the Indian securities market.

NCDs vs bonds

Non-convertible debentures (NCDs) and bonds are both fixed-income instruments. However, there are several differences between the two.

NCDs are issued by public companies, while bonds are issued by government entities, large companies, and financial institutions to raise capital for business purposes. Bonds are generally considered more secure than NCDs, which can be secured or unsecured. In the event of liquidation, bondholders are given priority over debenture holders in terms of debt repayment.

NCDs are a type of debt instrument, similar to bonds, that offer a fixed interest rate on investments. They are long-term financial instruments issued by companies for a specified tenure, promising to pay a fixed interest rate to investors. NCDs cannot be converted into shares or equities, and their interest rates depend on the issuing company.

NCDs offer benefits such as high liquidity through stock market listing, tax exemptions at the source, and safety, as they are issued by companies with good credit ratings as specified by the RBI. The credit rating of an NCD reflects the issuer's ability to service its financial obligations, such as paying interest and maturity proceeds on time.

When investing in NCDs, it is important to consider not only the returns but also other metrics such as credit rating, liquidity, and the tax impact on your portfolio. The credit rating indicates the likelihood of the issuing company defaulting on its interest and principal payments. A higher credit rating means a lower interest rate, and vice versa.

NCDs offer a high degree of safety, with ratings of AAA indicating the highest safety and the lowest credit risk. Advisors recommend choosing NCDs from well-established companies with high credit ratings to minimise the risk of default.

Tips for investing in NCDs

Non-convertible debentures (NCDs) are a popular investment option in India, particularly for those seeking regular income or higher returns from their debt portfolio. Here are some tips for investing in NCDs:

Diversification

NCDs in India are issued by numerous companies across different sectors. It is advisable to spread your investment capital across multiple NCDs from different companies to limit potential losses. Amol Joshi, Founder of Plan Rupee Investment Services, recommends avoiding concentration risk by diversifying your portfolio.

NPA Provision

Before investing, check the Non-Performing Assets (NPA) provision of the company. Ensure the company has set aside at least 50% of its assets for NPAs. A drop below this threshold indicates a decline in the company's financial condition.

Selling Time

The best time to sell your NCD in the secondary market for maximum profit is when the interest is due to be paid by the issuer. This is when liquidity is highest, and you can make the highest profits.

Debt Level

Conduct a detailed background check on the NCD-issuing company, especially its asset quality. Avoid investing if the company has unsecured loans amounting to more than half of its overall assets.

Credit Rating

Check the credit rating of the NCD. A high credit rating indicates a low probability of default. A rating of AAA signifies the highest safety and a very high ability to continue financial payments. However, keep in mind that credit ratings can change during the term of the NCD.

Lock-in Period

NCDs typically come with a lock-in period, during which you must stay invested until maturity. These periods can range from 2 to 20 years, allowing for goal-based planning.

Tax Implications

Interest earned on NCDs is taxable at your income tax rate. Consider your post-tax returns and the tax impact on your portfolio before investing.

Company Fundamentals

Look beyond the returns and focus on the fundamental strength of the issuing company. Assess the company's financial health, business growth prospects, and corporate governance. Understand the default and liquidity risks before investing.

Liquidity

NCDs are generally illiquid, so don't rely on the secondary market for an early exit. If liquidity is important to you, consider other debt instruments that can be bought and sold more easily.

Tenure

Choose the tenure of your NCD based on your financial goals and when you need the money. If you need regular income, opt for an NCD with a defined payout option. If you don't need regular income, the accumulated interest option may be more efficient due to compounding.

Minimum Investment

The minimum investment amount for NCDs in India is typically Rs 10,000, but this can vary depending on the specific NCD issue.

Risk and Return

While NCDs offer high returns and low risk, don't be lured solely by the returns. Consider the risk factors and assess whether the interest coupon justifies the potential risk.

Remember, investing in NCDs requires careful consideration of various factors. Always do your research and assess your risk appetite and investment goals before making any investment decisions.

Frequently asked questions