Non-convertible debentures, commonly known as NCDs, are a popular investment option for many individuals due to their attractive interest rates. However, NCDs cannot be converted into equity shares, which distinguishes them from other types of debentures. The following is a detailed guest post about NCDs, their types, features, and considerations for investing in them.
What are Non-Convertible Debentures?
To start with, it’s important to understand what NCDs are. NCDs are a type of debenture issued by companies to raise funds. Unlike Convertible Debt (CDs), which can be converted into equity shares at the investor’s discretion, NCDs do not offer this option. This non-convertibility is the defining characteristic of NCDs, making them a fixed-income instrument with a predefined interest rate and maturity period.
Companies issue NCDs to meet their funding requirements and often offer them at higher interest rates to attract investors. The interest rates on NCDs are typically higher than those offered by bonds or Fixed Deposits (FDs), making them an appealing option for investors looking for better returns. However, the higher interest rate also reflects the higher risk associated with NCDs, especially when compared to secured financial instruments.
Types of NCDs
When investing in NCDs, it’s crucial to understand that there are two main types: secured and unsecured.
- Secured NCDs: Secured NCDs are backed by the issuing company’s assets. This means that in the event of a default, investors have a claim on the company’s assets, which reduces the overall risk of the investment. The backing of assets provides a safety net, making secured NCDs a slightly safer investment than unsecured NCDs.
- Unsecured NCDs: On the other hand, unsecured NCDs do not have any collateral backing. This absence of security makes them riskier for investors. Unsecured NCDs often offer higher interest rates to compensate for this increased risk. While the potential returns are greater, the lack of asset backing means that investors could lose their entire investment if the issuing company defaults.
Key Features of NCDs
Before diving into an NCD investment, it’s essential to grasp the key features that define these instruments. These features play a significant role in determining whether NCDs are suitable for your investment portfolio.
- Interest Rates: One of the primary attractions of NCDs is their higher interest rates. Because NCDs carry a higher risk than bonds and FDs, companies offer more attractive returns to lure investors. This higher interest rate can make NCDs a lucrative investment, particularly for those looking for better returns in a low-interest environment.
- Maturity and Liquidity: NCDs come with a fixed maturity date, which means your investment is locked in until that date. However, unlike FDs, NCDs cannot be withdrawn before maturity. Despite this, they offer some degree of liquidity because they are often listed on the stock exchange, allowing investors to buy or sell them in the secondary market.
Things to Consider Before Investing in NCDs
Investing in NCDs can be rewarding, but it’s not without risks. Here are some critical factors to consider when making a well-informed investment decision.
- Credit Rating: An NCD’s credit rating is a crucial indicator of its safety. Credit rating agencies like CARE, CRISIL, ICRA, and FITCH assign ratings to NCDs based on the issuing company’s creditworthiness. An NCD with an AA rating or higher is generally considered safer, while those with lower ratings carry a higher risk of default.
- Company’s Debt Level: Examining the issuing company’s debt structure is vital. If a company allocates more than 50% of its assets to unsecured loans, it might be a sign of financial instability. Avoiding such companies can help mitigate the risk of investing in NCDs.
- Capital Adequacy Ratio (CAR): The Capital Adequacy Ratio (CAR) measures a company’s financial strength and ability to withstand potential losses. A CAR of 15% or higher indicates that the company has enough capital to cover its liabilities and is less likely to default on its NCDs.
How to Invest in NCDs?
Investing in NCDs is a straightforward process that can be done either online or offline. If you choose to invest online, you will need a dematerialised account. This account allows you to hold your NCDs in electronic form, facilitating easier transactions and reducing the risks associated with holding physical certificates. Many investors prefer buying NCDs during the initial public offering by the issuing company, but they are also available for purchase in the secondary market.
Benefits of Investing in NCDs
NCDs can offer several benefits to investors, making them a valuable addition to an investment portfolio.
- Diversification: Incorporating NCDs into your portfolio can provide diversification, which helps spread risk across different asset classes. This is particularly useful in reducing the overall risk of your investments.
- Higher Returns: NCDs’ higher interest rates make them attractive options for investors seeking better returns. This is especially true in a low-interest-rate environment where traditional savings instruments may not offer substantial returns.
- Priority in Repayment: In the unfortunate event of the issuing company’s liquidation, NCD holders are given priority over equity shareholders in the repayment process. This added security can provide peace of mind to investors.
Conclusion
NCDs present a compelling option for investors looking for higher returns and portfolio diversification. However, higher returns come with increased risk, so assessing your risk appetite and financial goals is essential before investing thoroughly. Be sure to consider the credit rating, the company’s debt level, and other financial ratios before committing your funds. If you are comfortable with the risks, NCDs can be a rewarding addition to your investment portfolio.
