NCDs, or non-convertible debentures, are a type of debt instrument issued by companies to raise funds for various purposes, such as business expansion, working capital requirements, and debt repayment. As the name suggests it can not be converted into equity capital. It has a fixed rate of interest and a fixed maturity date, at which point the principal amount is paid back to the investors. However, based on pre-defined terms it can be payable at various frequencies like- monthly, quarterly, half-yearly, or annually too.
What are the Features of NCDs?
A few key features of NCDs that make them an attractive option to invest for investors are highlighted below:
- Fixed-rate of Interest: NCDs offer a fixed rate of interest to their investors, which means that the interest earned on the investment is known in advance. This can make it easier for investors to plan their finances and returns for the future.
- Credit Rating: Typically NCDs that are issued by the corporates have to be rated by Credit Rating agencies, which gives investors an idea of the creditworthiness of the issuing company. Based on their risk-taking capacity they can make the decision to invest in the NCDs or not.
What are the Pros of investing in NCDs:
The key advantages of investing in NCDs are discussed hereunder:
- High and predictable Rate of Returns: NCDs typically offer higher interest rates compared to traditional fixed deposits, making them an attractive option for investors looking to earn a higher return on their investment. Also, the interest on NCDs are fixed and hence predictable.
- Low Risk as compared to stock: NCDs are rated by credit rating agencies. The higher the rating, the lower the risk of default, making NCDs a relatively low-risk investment option. Also, if these are secured NCDs then there will be some underlying collateral loans which make it a safer option to invest when comparing it to investments in equity stocks.
- Diversification: Investing in NCDs can provide diversification benefits to an investor’s portfolio. It can also act as a hedge against inflation as the rate of return on NCDs is generally higher than on government bonds and FDs.
- Tradable on the exchange: In the case of listed NCDs, they can be bought and sold just like shares. This makes investment options in NCDs more lucrative compared to investments made in fixed deposits. In case of liquidity requirements during the loan tenure, investors can sell them through the exchange without any exit load or penal charges.
What are the Cons of investing in NCDs:
While investing in NCDs can be a good option for investors looking for higher returns with moderate risk, they also come with certain disadvantages. Let’s try to understand below:
- Credit Risk: There is always a credit risk in NCDs. It means that the company may not be able to pay the interest or return the principal amount as promised. This risk is higher for NCDs issued by companies with lower credit ratings.
- Liquidity Risk: Even though NCDs are listed on stock exchanges, they may not have a strong secondary market, which can make it difficult for investors to sell their NCDs at the desired price and time.
- Risk of early redemption: Some NCDs may have an early redemption feature by way of call options. which means that the issuer has the right to redeem the NCDs before the maturity date. This can affect the financial planning and the return on that investment for the investors.
Comparison between NCD Vs. Equity Stocks
- Risks: NCDs are considered to be relatively low-risk investments when comparing it to stocks, as the issuer promises to pay a fixed rate of interest and principal amount on the maturity date. On the other hand, equity stocks are considered higher-risk investments as the value of the stock can fluctuate based on a number of factors, including the performance of the company and the overall external market conditions.
- Ownership: As briefed above, NCDs are debt instruments, meaning that the investor is a lender to the company and is not entitled to any ownership rights. On the other hand, equity stocks represent ownership in the company and the holder becomes eligible for a share of the company’s profits and assets.
- Maturity: NCDs have a fixed maturity date, which is the date on which the principal amount is returned in full to the investor. This allows investors to plan accordingly for their future returns. On the other hand, there is no fixed maturity date for equity stocks, and the investment can be held indefinitely. This means an investor has to watch and plan for his finances based on market volatility.
Comparison between NCD Vs. FD
- Return: NCDs typically offer a higher rate of return compared to traditional fixed deposit options available in the market. Hence, it makes an attractive option for investors who are fine to take some extra risks to earn a higher return on their investment.
- Maturity/Liquidity: Some NCDs issued by the Companies offer periodic interest and principal payments, making NCD investment a convenient option for investors looking for periodic funds. On the other hand, FDs have a fixed maturity date, which is the date on which the principal amount and the interest are returned to the investor and early withdrawal can attract a penalty or a reduction in the agreed interest rate.
NCDs are an effective mode of raising funds for companies. The credit rating of the company has a direct impact on the coupon rate offered by the company. From the perspective of investors also, NCDs, or non-convertible debentures, can be a better option to invest for investors who are looking for a higher rate of return than traditional fixed deposits, Post-office time deposits, etc., and are willing to take on a moderate level of risk.
They offer a fixed rate of interest, a fixed maturity date, and certain tax benefits. However, it’s important for investors to consider the risks before investing in NCDs. These include default credit risk, lack of data transparency, risk of a credit downgrade, and risk of early redemption. By understanding the benefits and risks, investors can make more informed decisions and diversify their investments to minimize risk. It’s always advisable to consider all the aspects before making any investment decisions.
Frequently Asked Questions (FAQs)
- What are NCDs?
NCDs, or non-convertible debentures, are debt instruments issued by companies to raise funds. It offers fixed-interest returns to its investors over the tenure of the loan.
- How do I invest in NCDs?
NCDs can be directly purchased from the issuer company or they can be purchased in the secondary market also. The units will be received in your Demat account. However, it is advised to do your research before investing in any NCDs.
- Is there a minimum investment requirement for NCDs?
The minimum investment requirement for NCDs can vary depending on the issuing company. Some NCDs have a minimum investment of a few thousand rupees say Rs. 10,000 only, while others may have a minimum investment of one lakh also. It’s important to check and plan your investment before investing in NCDs.
Anuj is an investment professional with a demonstrated history of working in Debt Capital Markets. He has completed his B.Com (Hons) in St. Xavier’s College, Kolkata and holds PGDM (Finance) degree from GIM. He is currently working as Investments Principal at Wint Wealth. He has been working in the debt capital market space for the past 4+ years and is also an NISM certified mutual fund expert.