Retail investors are preferring to invest in non-convertible debentures (NCDs) to earn higher returns than bank fixed deposits. With a fall in bond yields and appreciation in bond prices, investors are chasing debt investments.
After the successful issue of Edelweiss Housing Finance, mortgage lender Dewan Housing Finance (DHFL) came out with NCDs early this month with coupon rates in the range of 8.83% to 9.30%, resulting in an effective yield of 9.20% to 9.30% for the individual investors. On the other hand, the interest rate of State Bank of India’s fixed deposits for over three-year tenure is 7% and 7.25% for senior citizens.
The maiden NCD issue of DHFL, worth up to R4,000 crore, was fully subscribed on the very first day of the issue. The issue had an AAA rating from both CARE Ratings and Brickwork Ratings. Investors had the option of applying to the NCD both in demat and physical forms and choose between three, five and 10-year tenors with monthly, annual and cumulative payment options.
Companies issuing non-convertible debentures offer higher rates because they carry default risk compared with bank or post office deposits. Also, unlike bank deposits, NCDs are not insured against any default and have longer tenure. So ideally, investors must invest in NCDs that at least have an AAA rating.
Unlike bank deposits, NCDs are not as liquid as the secondary market, for corporate bond is not well developed in India. Which means, without a vibrant secondary market for these bonds, an investor may have to sell at a discount. However, in the case of bank deposits, for instance in SBI, there is no premature withdrawal for retail term deposits of up to R5 lakh provided the deposits have remained with the bank for at least seven days. For term deposits above R5 lakh but less than R1 crore, the prepayment penalty is 1% for all tenors.
Investing in NCDs makes sense for those in the 10% to 20% tax brackets. Analysts say within an investor’s overall debt allocation, one should not invest more than 25% in company fixed deposits or non-convertible debentures, given their higher risk profile and poor liquidity compared with bank deposits and debt mutual funds. Moreover, an investor should not invest more than 5% of one’s portfolio in companies which offer abnormally high yields, as the default rate can he higher in such companies.
Non-convertible debentures are of two types — secured and non-secured. The secured ones are backed by assets, wherein if the company is unable to fulfil its obligations, the assets are liquidated to repay the investors. So, secured non-convertible debentures pay lower coupons than non-secured ones.
NCDs cannot be converted into equity shares. After maturity or redemption, the company gets back its debenture and the debenture holder the principal invested, along with the interest accrued. Listed debentures are treated as long-term capital assets if the non-convertible debentures are held for a period of 12 months. Analysts say one should invest in non-convertible debentures only if he can hold them till maturity.
If non-convertible debentures are sold on the stock exchange within 12 months from the date of allotment, short-term capital gains/losses (STCG) will arise. But beyond that period, it will be treated as long-term gains/losses. Interest earned from non-convertible debentures will be clubbed with the individual’s total income and taxed at marginal income tax rates. Analysts say conservative investors should also look at options like post office saving schemes, tax-free bonds and debt mutual funds.