Should one opt for bonds or fixed deposits?

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.

*This example is only for illustration purposes and is not a recommendation

The 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.

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.