Regarding investment options, the Indian financial landscape offers its investors myriad choices. However, the complexity and lack of information about certain investment instruments often leave investors quandary. Among these, Non-Convertible Debentures (NCDs) are an asset class that often goes under the radar, primarily due to the absence of comprehensive information for the average investor. But fret not! This guide is here to help you easily navigate the world of NCDs.
What are NCDs?
Simply put, NCDs are fixed-income instruments corporations issue for raising long-term funds. Unlike shares, they do not convert into equity shares of the issuing company. So, what differentiates Non-Convertible Debentures from similar-sounding instruments like bonds and shares?
- Definition of NCDs: NCDs are loan-linked securities issued by a company, promising a fixed return on investment. Investors essentially lend money to the issuing company and receive interest payments.
- Differentiating NCDs from bonds and shares: While bonds are debt instruments, they usually have a longer maturity period than NCDs. Shares, however, represent ownership in a company, unlike NCDs.
- Role of NCDs in corporate fundraising: NCDs form a vital part of a company’s debt capital, helping them fund various business operations without diluting their equity.
Why Invest in Non-Convertible Debentures?
Understanding why you should consider investing in NCDs can clarify their place in your portfolio. Here are some reasons to ponder:
- High-interest rates: Compared to fixed-income securities like FDs or savings accounts, NCDs generally offer higher interest rates, making them an attractive option for steady income.
- Safety of investment: NCDs, particularly secured ones, are backed by the company’s assets. Hence, NCD holders have a higher claim over the assets in the unlikely event of the company going bankrupt.
- Regular income: NCDs pay interest at a specified rate and frequency, providing a predictable income stream for investors.
- Comparison with other investment avenues: NCDs provide better returns than traditional investments in the current low-interest-rate scenario.
These unique features make NCDs an attractive option for investors seeking regular income and safety of capital. However, it’s crucial to note that, like all investments, NCDs also come with their share of risks, which we will address in the later sections.
Understanding Types of NCDs
Just as mutual funds offer different schemes based on investment goals, NCDs come in various types to suit the risk appetite and requirements of different investors.
- Secured vs. Unsecured NCDs: Secured NCDs are safer and backed by the issuer’s assets. Unsecured NCDs, though riskier, offer higher interest rates to compensate for the risk.
- Callable vs. Non-Callable NCDs: Callable NCDs allow the issuer to redeem them before maturity, while non-callable NCDs do not offer this option.
- Redeemable vs. Irredeemable NCDs: Redeemable NCDs can be redeemed on the maturity date, while irredeemable NCDs remain in effect indefinitely until the issuer calls them back.
Each of these types serves a specific purpose and has different risk-return parameters. Therefore, it’s crucial to understand them before making an investment decision.
Risks Associated with Investing in NCDs
Though NCDs may seem attractive with high-interest rates and regular income, they are not devoid of risks. Being aware of these risks can help investors make informed decisions.
- Credit Risk: This is the risk that the issuer might default on interest or principal repayment. One can mitigate this risk by investing in NCDs issued by companies with high credit ratings.
- Liquidity Risk: Unlike shares, NCDs aren’t actively traded, which might make it difficult for investors to exit before maturity.
- Interest Rate Risk: Rising interest rates can negatively impact the price of NCDs. However, this risk doesn’t affect those who hold their NCDs until maturity.
Investors should know these risks and align their NCD investments with their risk appetite and financial goals.
Comparison: NCDs vs. NPS
Investors often explore different investment options to diversify their portfolios. Comparing NCDs with another popular investment scheme, the National Pension Scheme (NPS), can provide a holistic view:
- Returns: While NCDs offer a fixed rate of return, the NPS returns are linked to market performance, making it potentially higher and more volatile.
- Liquidity: NCDs are usually less liquid than NPS. While NCDs can only be sold in the secondary market, partial withdrawals from NPS are allowed after three years of investment under specific circumstances.
- Risk Profile: NCDs come with credit, liquidity, and interest rate risk. On the other hand, NPS, being a market-linked product, carries market risk.
- Tax Benefits: NCDs and NPS offer tax benefits, but they differ in the extent and nature of the benefit.
Understanding the differences between NCDs and other investment options like the National Pension System can help investors diversify their portfolios and spread the risk.
Non-Convertible Debentures are an excellent investment option for those seeking fixed, regular income. However, like any investment, they come with certain risks. It’s essential for investors to fully understand the nature, benefits, and risks associated with NCDs before adding them to their investment portfolio.