Non-convertible debentures (NCDs) range from 2-10 years and offer high-interest rates than traditional banks. The recently launched NCDs are offering high-interest rates of 10%-11% even as the debt markets are spooked. Given that the big corporates such as IL&FS, Essel Group are facing troubles and carry a high risk of default. The recent NCDs include Muthoot Finance offering 10%, Indiabulls Consumer Finance giving 11%. Given below is the detailed analysis of whether it makes sense to invest in NCDs in this volatile market:
- Beware of the risks
Generally, the consumers do not invest in NCDs due to the higher risk involved in it. The biggest risk is related to the default of the company. Currently, the NBFC companies are going through liquidity crisis and higher rated papers are defaulting. As NCDs are not liquid, it becomes very difficult to exit before maturity. The investor’s portfolio is confined to a single company as compared to the diversification of his/her investment, thus jeopardizing the capital in unfavorable times.
- Not a tax-efficient instrument
Investors can bet on mutual funds instead of NCDs, which provides better diversification, liquidity and, professional fund management. Retail investors should not be swayed by the higher interest rates offered by NCDs and should keep in mind the risk associated with these instruments.
- Unhealthy investments in the current market
The current market scenario is unhealthy for investing in NCDs. There are serious concerns rising from the liquidity crisis, firms unable to refinance debt from mutual funds, liquidity for debt fund in secondary markets. This can be witnessed from the rising interest rates of NCDs. In simpler terms, higher the risk, higher are the returns n future. If mutual funds cannot generate good returns from the capital employed by the investors, it would be prudent to stay away from the NCDs at present.
- Credit Ratings
Investors can invest in retail NCDs post checking the required credit ratings given by the agencies. Most companies do get ratings from ICRA, Crisil, etc. Several good quality NCDs offer higher-risk adjusted returns owing to a higher credit crunch. Also, the investor should assess the company’s financial health before investing. Generally, short-to-medium NCDs carry lower risk and probability of default is minuscule. Overall, its good to ride the wave of NCDs and generate better returns.
- Higher yield than FDs
The NCDs have a higher yield but one should not forget the credit risk attached to it. This risk can largely be overcome or judged by checking the credit rating agency. FD offer an interest rate of 7%-8% while the NCDs can generate a cumulative return of more than 9% per annum.
For investors looking for fixed-income instruments can invest in debt funds, which spread investments in 40 categories, thus reduces the risk. Secondly, the tax liability is reduced if the mutual fund is held for more than three years. Thirdly, investments can be pulled out anytime either full or part in situations like liquidity or credit crisis. The returns from mutual funds will mirror the market.