Rohan is looking for a good investment opportunity which offers him better returns and at the same time manages risk and liquidity to a large extent. He meets Jacob, an investment advisor, to ask him about Non-Convertible Debentures (NCD) as an investment avenue since he heard it offers a good mix of risk return and ease of liquidity.
Rohan: What are NCDs?
Jacob: NCDs are fixed income debt instruments issued by a company wherein a company agrees to pay you a fixed rate of interest on your investment for a specified period in order to raise money from market for business purposes. Unlike convertible debentures, NCDs cannot be converted into shares of the issuing company. To make up for this limitation, you enjoy steady returns, liquidity, low risk and tax respite as opposed to convertible debentures.
NCDs may be held by individuals, banking companies, primary dealers, corporate bodies registered or incorporated in India and unincorporated bodies, Non-Resident Indians (NRIs) and Foreign Institutional Investors (FIIs).
Rohan: Are there different types of NCDs?
Jacob: Yes, an NCD can be secured or unsecured. A secured NCD is backed by the assets of the company and if the company fails to pay the obligation, the investor holding the debenture can claim it through liquidation of these assets.
Whereas in unsecured NCD, there is no asset backing in the case of unsecured NCDs. However, any company seeking to raise money through NCD has to get its issue rated by agencies such as CRISIL, ICRA, CARE and Fitch Ratings.
Rohan: What are the benefits of investing in NCDs?
Jacob: You will benefit from high interest rates. The rate of return on NCDs is around 11-12%. This is high compared to most investment options. For example, fixed deposits (FDs) are another popular avenue where people put their money for regular returns. However, the returns are much lower.
It offers you flexibility. There are various interest pay out options including monthly, quarterly, semi-annually and annual payments. The maturity period for an NCD can be anywhere between 90 days to 20 years. This gives you the flexibility to choose between short and long tenures based on your investment goals.
Also, it offers greater liquidity. Since they are listed on the stock exchanges, NCDs are easy to withdraw. Redeeming your NCD investment may be a little tougher than selling regular stocks, but they are more liquid than bank fixed deposits. There is no Tax Deducted at Source (TDS) on listed debentures. But you have to pay attention to ratings. Every company that seeks to raise money through an NCD is rated by agencies such as Fitch, Brickwork Ratings, CRISIL, ICRA and CARE. These rating agencies rate the company based on its ability to service its debt on time. Credit Rating necessarily is not a guarantee of sorts. Higher the rating, lower would be the interest rates, in a given period and lower the rating, higher would be the interest rate, and higher would be the perceived credit risk.
You also have the option of holding bonds in ‘Demat Form’ makes your investments easy to handle and monitor.
Rohan: What are the Tax Implications of NCD?
Jacob: If you hold the NCD till maturity, the interest earned is added to the total income and taxed at marginal rate of income tax depending on the tax-slab you belong to. Interest income earned is taxable with these NCDs and the investors are required to pay tax on the interest income as per their respective tax slabs. TDS @ 10% will be deducted if these NCDs are held in physical/certificate form and annual interest income is more than Rs. 5,000. NCDs held in demat mode will not attract any TDS.
But if you decide to sell the NCD on exchange before one year you will have to pay Short Term Capital Gains Tax at applicable rates depending on the tax slab you fall into. And if you decide to sell on exchange before maturity but after one year you will have to pay Long Term Capital Gains Tax at 20% with indexation and 10% without indexation.
Rohan: How can I apply for NCDs?
Jacob: You can apply through a physical application and submit the duly signed forms at the authorized collection points or branches. Or through the trading account, if they have one through any stock-exchange member. Most of the top full-fledged financial advisory firms provide an option to bid online through their customer care portals / call centres.
NCDs can provide stable cash flows for the chosen tenure. They are especially attractive in a declining interest rate scenario, as one would be in a position to lock-in the offered rates. Investors can diversify their Debt / Fixed Income portfolio by allocating say 10% to 20% of the kitty. It’s a good choice, as they tend to optimize the overall fixed income portfolio’s returns. That said, investors should not go over-board on allocation into NCDs.