With falling interest rates on deposits, retail investors are looking at non-convertible debentures (NCDs) in the secondary market. Investing in NCDs makes sense for those in the 10% to 20% tax brackets, as those in the lowest tax bracket can get higher post tax returns. Individuals are preferring to buy NCDs of companies like NTPC, L&T Infra, Sriram Transport. The bonds are better than bank fixed deposits as they offer higher yields and are liquid, too. These bonds are sold and can be bought from the stock exchange.
At present, NCDs in the secondary market can yield between 7.5 to 9.5% depending on the time for maturity. NCDs, including subordinated debentures issued through private placement, constitute a significant source of borrowings for companies in India.
Secured and non-secured
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. Companies issue NCDs to raise long-term funds. These debentures cannot be converted into shares or equities and lenders offer a higher rate of return compared to convertible debentures. All NCDs issued have to rated by rating agencies such as CRISIL, ICRA, etc. It is always advisable to buy NCDs which have highest rating.
Investors should buy NCDs depending on their liquidity needs. If one is looking at liquidity after five year’s time, then it is better to buy those NCDs which will mature in 2022. Those looking at long-term holding can buy bonds which will mature after 10 or 15 years for higher returns.
Secured non-convertible debentures pay lower coupons than non-secured ones. Companies issuing non-convertible debentures offer higher rates because they carry default risk compared to bank or postal deposits. Investing in NCDs makes sense for those in the 10% to 20% tax brackets, as those in the lowest tax bracket can get post tax returns around 7% for a 120-month tenure. One should invest in non-convertible debentures only if he can hold them till maturity.
Investors can buy NCDs from the primary market when a company comes out with public offer. Mahindra and Mahindra Financial Services (Mahindra Finance) is planning to raise up to Rs 29,000 crore through issuance of NCDs and is seeking shareholders’ nod for the same.
At the time of public issue NCDs, an investor can buy the bonds by submitting a physical form with the details of PAN and identity. One can also invest online through demat account. Analysts say investors must factor in that NCDs have liquidity risk. Even if they get listed, low volumes may not enable investors to exit prematurely.
After maturity or redemption, the company gets back its debenture and the debenture holder the principal invested, along with the interest accrued. The 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 within an investors’ overall debt allocation, it is preferable not to invest more than 25% in company fixed deposits or non-convertible debentures, given their higher risk profile and poor liquidity compared to bank deposits and debt mutual funds. They also advise not to invest over 5% of one’s portfolio in companies which offer abnormally high yields.
Analysts say investors should look at NCDs for asset diversification, which would help them to get higher returns in the long-run.