Should you park your funds in non-convertible debentures?

Usually, conservative investors choose to invest in fixed deposits for the sake of safety and guaranteed returns. However, there are other financial instruments such as non convertible debentures, which work better than fixed deposits when it comes to returns.

Pankaj Mathpal, Optima Money Managers compares NCDs to fixed deposits. "Liquidity-wise, definitely the bank fixed deposit can be liquidated anytime. Debentures are listed on the stock exchange where these are traded but it will depend on the demand. If there is a buyer only then you can sell it. So, there is not much liquidity in case of a debenture. Safety wise, ratings may not be very helpful but you have to see the business of the company. So, if the business model of that company issuing the debenture is good and trustworthy then you can invest in it."

Below is the edited transcript of Mathpal's interview with CNBC-TV18.

Q: Are non-convertible debenture (NCD) a good option for retail investors?

A: First, I’ll explain what is debenture. Basically, debenture is a fixed income instrument, which offers a fixed interest for a fixed term. Now, this debenture if it is non-convertible, it means that it cannot be converted into the company’s equity shares. These debentures may be secured or unsecured.

A secured debenture is backed by assets; it means if the company fails to pay its obligations, in such case, these assets can be liquidated to pay investors’ money.

These debentures or NCDs are basically rated by independent rating agencies like ICRA, CRISIL or Fitch so the companies, which are rated as AA or AAA are better. These offer good interest rate compared to bank interest. So it definitely makes a good choice for investment.

But investors should see that they should invest in companies with higher rating. They should not fall prey to the temptation just because these are offering good interest rate because they should understand the risk involved in this as compared to bank’s fixed deposit. Bank’s fixed deposit (FD) offers a fixed interest and it is insured upto Rs 1 lakh.

Q: Can you liquidate debentures? Also, how safe are these ratings? To what extent can it be enforced? Are debenture trustees powerful enough to ensure that there is some collateral and some money will come back?

A: Liquidity-wise, definitely the bank fixed deposit can be liquidated anytime. Anytime person wants to withdraw his fixed deposit that is possible but these debentures are listed on the stock exchange where these are traded but it will depend on the demand. If there is a buyer only then you can sell it. Inspite of the fact that it is listed, it is not necessary that you will be able to sell it. So, there is not much liquidity in case of a debenture.

Safety wise, ratings may not be very helpful but you have to see the business of the company. So, if the business model of that company issuing the debenture is good and trustworthy then you can invest but still it has a reference AA, AAA rating.

A retail investor who does not have much knowledge about the business of the company can refer to those ratings. If it is rated better it is safer compared to the company which is not rated as AA, AAA.

Q: What is the tax effectiveness of an FD with interest rate of 8% and debenture with 12%?

A: Rate of interest or coupon offered on debenture is exactly the same; it works like it works with interest. It is income from other sources, which is clubbed to your other income and charged as slab rate 10%, 20% or 30%. If an investor is selling this debenture before maturity, the premium attracts capital gain tax. So, the coupon which is being paid regularly is as good as interest. But the capital appreciation, if any, will be considered as capital gain.

Q: Should an investor invest in IIFL NCD? There are some interest payout options as well. What would be your advice on IIFL?

A: When you want to invest, you should see liquidity, safety and return on the investment product. Return-wise, definitely it is offering 12.75% annual coupon, which is really attractive. But the company is in the broking business, which is not very attractive from the safety point of view.

Also, in terms of liquidity, if there is demand in future in the secondary market then only you will be able to sell it. Understand the risk in this and then invest a part of your investable surplus.