Non-convertible debentures (NCDs) play an essential role as an appealing investment option for both individual and institutional investors in the area of finance and investment. NCDs are financial instruments that corporations utilise to raise capital from the market. These instruments offer fixed returns over a predetermined period. Unlike convertible debentures, NCDs do not provide an option to convert into equity shares.
Non-Convertible Debentures: Features and Benefits
In this article, we will delve deeper into the intricacies of non-convertible debentures, why they are better investment options, and explore their features, benefits, and risk factors for investors.
Features of Non-Convertible Debentures
- Fixed Interest Rate: NCDs offer investors a predetermined fixed interest rate, which is paid periodically, typically on a quarterly, half-yearly, or annual basis. This feature provides investors with a steady income stream over the debenture’s tenor.
- Tenor: NCDs have a specific maturity period ranging from a few months to several years. Investors can choose the debentures that align with their investment horizon and financial goals.
- Credit Rating: NCDs are assigned credit ratings by recognized rating agencies, reflecting the issuer’s creditworthiness. Higher-rated NCDs offer lower risk but may provide slightly lower interest rates than their lower-rated counterparts.
- Secured and Unsecured NCDs: Non-convertible debentures can be either secured or unsecured. Secured NCDs are backed by specific issuer assets, providing investors with an added layer of security. Unsecured NCDs, conversely, are not backed by any specific collateral and rely solely on the issuer’s creditworthiness.
Benefits of Non-Convertible Debentures
- Fixed Income Stream: NCDs provide investors with a predictable and stable income stream. The fixed interest rate ensures that investors receive a predetermined return on their investment, regardless of market fluctuations.
- Diversification: Including NCDs in an investment portfolio can help diversify risk. By allocating a portion of the portfolio to NCDs, investors can balance out the volatility associated with other high-risk investments like equities.
- Higher Returns than Traditional Fixed Deposits: NCDs often offer higher interest rates compared to traditional fixed deposits offered by banks. This makes them an attractive investment option for those seeking higher yields without compromising the safety of their capital.
- Liquidity Options: NCDs are typically listed on recognized stock exchanges, providing investors with the opportunity to sell their holdings before maturity. This offers a degree of liquidity and flexibility to investors who may require immediate access to their funds.
What Makes NCDs a Better Investment Option in India?
Non-convertible debentures (NCDs) can be considered a better option to invest in for several reasons:
- Fixed Income: NCDs offer a fixed income stream in the form of periodic interest payments. The coupon rate is predetermined at the time of issuance, providing investors with clarity on the returns they can expect. This fixed-income feature can be attractive for investors looking for stable and predictable returns.
- Diversification: Investing in NCDs can serve to diversify a portfolio. They provide an alternative asset class to traditional equity investments. By including NCDs in a portfolio, investors can reduce overall risk by spreading their investments across different asset types and sectors.
- Capital Preservation: Non-convertible debentures are typically less volatile compared to equity investments. Since NCDs have a fixed maturity date and the principal amount is repaid at maturity, investors have a higher degree of capital preservation. This can be particularly appealing for risk-averse investors seeking more stable investment options.
- Regular Income: NCDs provide regular interest payments to investors, either semi-annually or annually, depending on the terms of the debenture. This regular income can be beneficial for investors who rely on consistent cash flow or are seeking a steady income stream.
- Risk Mitigation: While investing in NCDs carries a certain level of risk, the risk is generally lower compared to equity investments. NCDs are ranked higher in the capital structure, meaning in the event of bankruptcy or liquidation of the issuing company, debenture holders have a higher claim on assets than equity shareholders. Additionally, the credit ratings assigned to NCDs by rating agencies provide an indication of the issuer’s creditworthiness, helping investors assess the risk associated with the investment.
- Secondary Market Liquidity: Listed NCDs can be traded on stock exchanges, providing investors with liquidity and the option to exit their investments before the maturity date. This added liquidity can be advantageous for investors who may need to access their funds before the maturity period.
- Tax Efficiency: Depending on the tax laws of the country, NCDs may offer tax advantages compared to other investment options. For example, in some jurisdictions, interest income from NCDs may be taxed at a lower rate or may be eligible for certain tax exemptions. It is essential to consult with a tax advisor or consider the specific tax regulations in your jurisdiction to understand the tax implications of investing in NCDs.
Risk Factors Associated with Investing in NCDs
1. Credit Risk: Investing in NCDs involves credit risk, as the repayment of principal and interest is dependent on the issuer’s ability to honour its financial obligations. Investors should carefully evaluate the creditworthiness of the issuer before investing in NCDs.
2. Interest Rate Risk: Changes in market interest rates can impact the value of NCDs. If market interest rates rise, the market value of existing NCDs may decline, affecting their trade ability.
3. Liquidity Risk: Although they offer a certain degree of liquidity, the trading volumes of certain NCDs may be low. This can make finding buyers or sellers in the secondary market challenging, potentially affecting the ease of liquidating NCD holdings.
4. Tax Implications: Investors should be aware of the tax implications associated with them. Interest income from NCDs is typically taxable, and the tax rate may vary based on factors such as the investor’s income tax slab and the holding period of the debentures.
Non-Convertible Debentures are a compelling investment option for investors of all kinds. They offer fixed income streams, diversification benefits, and potentially higher returns than conventional fixed deposits. Investors are advised to conduct due diligence, evaluate the issuer’s creditworthiness, comprehend the associated risks, and consider their individual financial objectives and risk tolerance.