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    HomeNewsBusinessPersonal FinanceShould one opt for bonds or fixed deposits?

    Should one opt for bonds or fixed deposits?

    Juzer Gabajiwala of Ventura Securities tries to decipher a better investment alternative among bonds or fixed deposits.

    December 19, 2013 / 13:04 IST
    Juzer Gabajiwala Ventura SecuritiesInvestors are always on the look out for good investment opportunities. Companies usually use two routes to tap public funds as borrowings; one is through Fixed Deposits (FDs) and another is Non-convertible Debentures (NCDs/Bonds). Recently, several companies are trying to catch the attention of investors by offering NCDs at attractive interest rates.  When you come across NCD issues, do you wonder whether they are a good investment option in volatile times? or How are they different from corporate FDs?  Head-to-Head difference between NCDs and FDs:
    ParametersNon-Convertible Debentures (NCDs) / BondsFixed Deposits (FDs)
    SafetySecured debt instruments, backed by assets that depositors can claim if the company fails to repayUnsecured and hence more risky.
    LiquidityTradable on exchanges and hence easy pre-mature exits. Capital appreciation/depreciation possible in case of change in interest rate.Not tradable on exchanges and pre-mature withdrawal attracts a 1-2% lower rate, as per policy of Company. Returns are fixed
    Credit RatingIt is mandatory for issuers to get the instrument rated by at least one agencyMandatory for NBFCs but not for others.
    TaxationAs per the tax slab of the individual. Except Tax Free bonds, which are not taxableAs per the tax slab of the individual.
    TDS (Tax deducted at source)Listed NCDs in the demat form have no TDS applicable on their interest payoutTDS is applicable if interest exceeds Rs. 5,000 p.a.
    Interest Payout FrequencyAnnual or CumulativeMonthly / Quarterly / Annual & Cumulative
    Let’s take an example of the recent issue of Shriram Transport Finance Company’s NCD and its Fixed Deposit scheme to clarify investors’ dilemma while choosing between a Bond/NCD and a FD:Shriram Transport Finance Company came out with a secured NCD issue recently. The company also has an on-going FD scheme. Now, if the same company offers you an opportunity to invest in its secured Non- convertible debentures (NCDs) as well as its Fixed Deposit scheme, which one should you invest in?Shriram Transport Finance Co. Ltd.
    Shriram Transport Finance Co. Ltd.
    Debt InstrumentNon-Convertible Debenture IssueFixed Deposit Scheme
    Credit RatingAA/Stable by CRISIL &FAA+/Stable by CRISIL & MAA+/Stable by ICRA
    AA+ by CARE
    Tenor3 years5 Years3 Years5 Years
    Interest Rate11.25%11.50%10.75%10.75%
    OptionsCumulativeCumulative and Non-Cumulative
    Interest Payout FrequencyAnnuallyQuarterly, Half-Yearly and Yearly
    *This example is only for illustration purposes and is not a recommendationThe above illustration clearly shows that between the Shriram NCD and FD, the biggest differentiating factor is the Return component. The NCD offers 0.50% and 0.70% more than the FD for the three and five year tenures, respectively. Normally, if all things remained the same, a secured NCD should offer a lower return than a FD.Secondly, the tenures of the NCD and the FD are also similar and in the case of an NCD, you can hold the instrument till maturity or sell it in the secondary market. If you sell the NCD in the secondary market before maturity, the prevailing interest rates will determine your returns. Interest rates and bond prices share an inverse relationship; so if interest rates in the economy go up, the price of the NCD will go down and vice versa. However, in the case of an FD, there will always be a penal charge for pre-mature withdrawal, irrespective of the increase or decrease in interest rates.Credit Rating of the investment options is another factor to be considered. In the above case, both the NCD and FD are rated by CARE, CRISIL and ICRA. However, the FD has a slightly higher rating of AA+ than the AA for the NCD. Nevertheless, the difference is quite insignificant. The Fixed Deposit has various non-cumulative options for interest payout, namely quarterly, half-yearly and yearly as well as the cumulative option whereas the NCD has only an annual interest payout or cumulative option. In this case an investor could opt to invest in the FD if quarterly cash flow is a requirement.Key Factors to consider before investing in NCDs/FDsAs an investor, you should investigate various factors of different products which you can chose from. The key factors you should consider before investing in NCDs/Bonds/FDs are given below:
    • Credit Rating: One of the most important factors to consider while selecting an investment is the credit rating of the Bonds/NCDs or FDs. For instance, in the above illustration, the Shriram NCD is rated AA+ and above, whereas the Shriram FD is rated MAA+/Stable. Naturally, other things being equal, the instrument with the higher rating should be chosen.
    • Interest Rates: This is a very crucial factor while determining which investment opportunity to choose, based on the return component that an investment provides. If you want a regular income, you can pick those that pay interest on a monthly, quarterly and annual basis. If you just want to grow your wealth, you can opt for the cumulative option, where the interest earned is reinvested and paid at maturity.
    • Company Management: It is advisable to look for companies that have strong fundamentals. Companies that have future growth plans and are raising funds to increase their capacities can be chosen. You should see the debt-equity multiple of the issuing company and ensure that the company which you choose to invest in does not have a huge debt obligation or it might have trouble repaying the debt.
    Benefits of choosing NCDs over FDs:Bonds/NCDs are better than company FDs for the above stated reasons. Though the interest rates on Bonds/NCDs and company FDs are usually more or less the same, what tilts the balance in favour of Bonds/NCDs is the risk-return factor.  Investing in Bonds/NCDs helps to diversify one’s debt investment but make sure that it is a small part of your fixed income portfolio. If you are looking at a short-term investment fixed income investment option, Bonds/NCDs can be the right instrument for you.The author is the director of Ventura Securities.
    first published: Dec 17, 2013 04:30 pm

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