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| February 24, 2023

What are the pros and cons of investing in NCDs?

Companies regularly need capital infusion to carry out day-to-day operations or for business growth and expansion. There are several ways of raising capital, and issuing NCDs or Non-Convertible Debentures is one of them. Bonds are generally issued by large corporations, financial institutions, and government agencies for their long-term capital requirements. Both public and private sector companies issue bonds to raise funds. Debentures are generally issued by private companies for short-term capital requirements. Debentures are also a kind of bond that is not attached to collateral. Put simply, debentures are unsecured bonds. An NCD investment becomes particularly attractive when interest rates are falling.

What Are NCDs?

Debentures are generally issued by private companies for short-term capital requirements. Debentures are also a kind of bond that is not attached to collateral, thus unsecured. Since debentures are riskier than bonds, the interest rate on debentures is generally higher than bonds. Debentures that can be converted into shares are called Convertible Debentures (CDs) and those that cannot be converted into shares are called Non-Convertible Debentures (NCDs). NCDs have a higher interest rate than CDs as they are comparatively riskier than CDs.

Upcoming non-convertible debentures are initially issued by the company in the exchange and later traded in the secondary market. So, you can either choose to subscribe when a company announces an upcoming non-convertible debenture or buy later in the secondary market when it is trading.

NBFCs like Muthoot Finance have emerged as some of the biggest issuers of NCDs. Due to the enormous amount of trust placed in Muthoot Finance and superior credit ratings, Muthoot Non-Convertible Debentures are quite popular with investors.

Pros and Cons of Investing in NCDs

As with any investment, investing your hard-earned money should be as per your risk profile, risk appetite, and financial goals. An NCD investment could be a good portfolio diversification strategy. It should be noted that NCDs in finance terms are fixed-income securities that operate on the premise of ‘high risk- high return’. While investing in NCDs, care should be taken to verify the credibility of the issuing company.

Advantages of investing in NCDs

Feature	Key Advantages
Interest Rate	NCDs offer higher interest rates as compared to traditional investment options like bank FDs, government bonds or securities, etc. Generally, the NBFC NCD rate of interest is higher by up to 150-175 basis points than bank FDs.
Liquidity	NCDs are tradable in the share market, hence highly liquid.
Prioritization of Investors	Although NCDs are unsecured, investors are given priority over shareholders in the company’s profits.
Regulation	NCDs are closely monitored and regulated by the Reserve Bank of India.
Risk	Debentures typically have a first charge or a second charge on the assets of the issuer. Hence, NCDs are relatively safer compared to other unsecured forms of investment.
Taxation	No TDS is deducted on the interest earned from NCDs.

Disadvantages of Investing in NCDs

Feature	Disadvantages
Quality and Rating	Companies with average or below-average credit ratings also issue NCDs. These have a higher risk of default and may not return the principal and interest accrued upon maturity.
Shareholding	NCDs are debentures that cannot be converted to equity and thus, NCD investors cannot become shareholders.
Taxation	Although no TDS is deducted on the NCD interest, the interest is taxed according to your tax slab. The post-tax returns from NCDs may be quite lower as compared to other debt investment options like debt mutual funds or hybrid mutual funds.

Conclusion

If you are looking for ways to earn a regular income from fixed return investments, an NCD investment can be a good option. Furthermore, one of the most trusted brands in India, Muthoot Finance regularly issues NCDs and it could be a great addition to your portfolio.