High interest rates can lure investors to NCDs: Nirmal Bang

With the equity markets in a flux, investors are increasingly flocking towards the fixed income segment. This is because debt instruments seem to be a safer option in such times.

Making the most of this trend, a number of companies are offering non convertible debentures (NCDs) to mop up funds from the market. NCD is a security that has loans as its underlying assets. It cannot be converted into a stock at the end of its tenure and usually carries a rate of interest that is considerably higher than a convertible debenture.

In the past couple of months, a host of companies (most of which were non-banking financial companies or NBFCs) such as Shriram Transport Finance , Shriram City Union Finance , India Infoline Finance and Religare Finvest have mopped up more than Rs 2,000 crore from investors.

Two more NCDs - one from Muthoot Finance , an NBFC company that doles out gold loans and Kolkata-based Srei Infrastructure Finance are currently open for subscription and plan to raise another Rs 650 crore.

Simplifying NCDs

The DNA of an NCD is that of a corporate bond. This means the company raises money from you and you in return earn regular interest as income against your investment.

These NCDs are listed on the stock exchange, which means you are free to trade in it like any other secondary market instrument. As an investor it is your choice to either accumulate more debentures or sell them before their maturity. The price of an NCD will depend mainly on interest rates.

Though it is a debenture, unlike other debentures you cannot convert it into equity at the end of its tenure. There are two types of NCDs that can be on offer. You can have a secured NCD or an unsecured NCD. Secured NCDs, as is evident from the name itself, is an instrument that has underlying assets that can be liquidated to repay holders of this security in case there is a problem.

An unsecured NCD on the other hand is a financial instrument that does not offer any such guarantee. Therefore, if something goes wrong, then the investor will not get back the investment. Understandably, this is a kind of instrument that carries a higher rate of interest.

What to look out for

Interest rates may be the biggest incentive that draws an investor towards NCDs. However, as an investor there are certain things he/she needs to watch out for while opting for NCDs.

First and foremost the investor must look at the financial strength of the company. But looking at the profitability of the company is not enough. The investor should also check other factors such as sources of revenue of the company and whether the company has a diverse portfolio or it is majorly dependent on just one source. Since it is mostly NBFCs that are issuing NCDs now, also look out for the asset quality of the NBFC.

The asset quality of the company may be judged from its level of non-performing assets or NPAs. This is particularly relevant in case of gold loan NBFCs or companies that have a high exposure to sectors such as real estate, which is subject to volatility.

The credit quality of the company issuing an NCD may also be judged from the ratings it receives from credit rating agencies such as ICRA, CRISIL or CARE. All NCDs are assigned a rating before they make a debut and you can be assured of the safety or credibility of the company and even a guarantee of the rate of interest if the NCD has received a high rating from such rating agencies.

Are NCDs the right thing for you?

For those who are in the lower tax bracket and want to earn or are looking for an opportunity to diversify their debt portfolio, NCDs are a good choice. However, financial advisors advise their clients to tread carefully where NCDs are concerned. This is because there are a large number of NBFCs that are making a beeline to raise money from NCDs and their underlying assets have always been a cause of concern in the financial world.

Adequate amount of research needs to be done before choosing an NCD, say experts. And the NCD should not exceed more than 10% to 15% of their overall exposure to debt.

Source: Nirmal Bang's Beyond Market

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