Risk-averse investors should avoid NCDs

Retail investors seem to be buying non-convertible debentures (NCDs) aggressively. Recently, Muthoot Finance came up with an NCD issue of Rs 2,000 crore, which offered interest rate between 8.25 per cent and nine per cent. The company had planned to keep it open for a month but it was subscribed in a few days. Muthoot had kept 60 per cent of the issue for retail and high net worth individuals.

“After the success of the Muthoot Finance issue, more companies are in line to offer NCDs,” says Ajay Manglunia, executive vice-president and head of fixed income at Edelweiss Capital. Depending on the credit rating of the company, the interest rates are expected to be in the same range as Muthoot Finance. “The liquidity in the banking system and slower credit offtake would keep interest rates steady in the near future,” says Manglunia.

Unless investors understand the nuances of the business of the company offering NCD and the risks involved; they are better off investing in a fixed deposit or debt funds, according to investment advisors. “Many of those who have invested in the recent NCD issues are those who traditionally put their money in fixed deposits. They think that both products are similar as they offer fixed rates. But NCDs are not usually suitable for retail investors,” says Surya Bhatia, managing partner, Asset Managers.

Bhatia feels more investors are looking at NCDs compared to company deposits because, in the latter, money needs to be locked in for the tenure of the deposit. NCDs are listed on stock exchanges after the issue closes to give investors an exit option. In India, the secondary markets for debt are not well-developed. The buyers bid much lower, and the seller would need to exit at a loss if he needs the money urgently.

As NCDs carry credit risk, they are more suitable to those who wish to invest only five-eight per cent of their debt portfolio in a single company’s papers. This helps to contain the risk in the overall portfolio. Retirees or those nearing retirement should avoid NCDs, according to experts.

NCDs carry higher interest rates because they are riskier than fixed deposits. But some experts feel the risk-adjusted returns of NCDs don’t match up to that of fixed deposits, especially those that have the government’s backing. Malhar Majumder, a Kolkata-based financial planner, suggests investors should look at five-year Post Office Time Deposits, which offers 7.7 per cent returns. It’s the highest interest rate on deposits among banks and non-banking financial companies.

Those who are seeking higher returns and are in the highest tax bracket should look at short-term debt funds instead of an NCD. Debt funds invest in a portfolio of papers, which spreads the risk across companies. They are, therefore, safer than investing in a single issuer. Professionals evaluate the companies before investing in their papers. Debt funds are also more tax-efficient. If you remain invested for over three years, the tax liability decreases after considering indexation. In NCDs, all the gains are added to the income and taxed, according to the income tax slab.