With the recent decision by the Federal Reserve to reduce interest rates by 50 basis points in the US, there is a growing expectation that interest rates in India may also see a decline soon. This change in market conditions is causing many financial experts to recommend good quality debt instruments for investment. If you’re an investor looking for alternatives to bank fixed deposits (FDs) or mutual fund debt schemes, you might want to consider non-convertible debentures (NCDs) as an option. Currently, NCDs from several reliable companies are available on both the BSE and NSE stock exchanges.
But before you make any decisions, let’s take a deeper look at what NCDs are, their benefits, potential risks, and whether they are a good fit for your investment portfolio right now.
What Are NCDs and How Do They Work?
Non-convertible debentures (NCDs) are fixed-income financial instruments issued by companies to raise capital. Investors who buy NCDs receive a fixed interest income, which can be paid out quarterly, half-yearly, or annually. Unlike equity, NCDs do not convert into shares but offer steady returns. Most NCDs have a maturity period that ranges between one and seven years, and companies use them to meet long-term funding needs.
There are two types of NCDs available for investors:
- Publicly Issued NCDs: These are open to retail investors and are typically offered with a face value of Rs 1,000.
- Privately Placed NCDs: These are primarily for institutional investors or family offices, with a face value of at least Rs 1,00,000. A large share of the NCD market, almost 98.5%, is dominated by privately placed bonds.
Are There Risks Involved in Investing in NCDs?
Although NCDs can provide higher returns compared to traditional bank FDs, they come with a certain level of risk. Unlike bank deposits or government bonds, NCDs are not entirely risk-free, especially if the issuing company faces financial challenges. This is why experts advise investors to choose NCDs with high credit ratings from trusted companies to minimize risk. For example, NCDs issued by Adani Enterprises were well-received in the market, with attractive returns between 9.25% and 9.90% per annum and maturities ranging from 2 to 5 years.
Understanding Tax Implications on NCDs
One important factor to consider when investing in NCDs is the taxation on interest earned. The interest is taxable and is added to your total income, which means it will be taxed according to your income tax slab. Moreover, if you sell NCDs on the stock exchange, the capital gains from that sale are also subject to tax. If you sell within 12 months, the gains are taxed as short-term capital gains according to your income tax slab. For NCDs held for more than 12 months, a long-term capital gains tax of 12.5% applies, but there is no indexation benefit available.
Why NCDs Are Becoming Attractive in a Low-Interest Environment
Given the current market scenario and expectations of lower interest rates in India, NCDs with higher yields are gaining traction. This is especially true for investors who are looking for stable returns. Experts believe that NCDs could be a good investment for individuals who fall under lower tax slabs and seek liquidity, as these instruments can be bought and sold on exchanges like the BSE and NSE. Companies like Tata Capital Financial Services, Shriram Transport Finance, and M&M Financial Services offer NCDs on these exchanges.
Investors should keep in mind, however, that purchasing NCDs through stock exchanges may incur brokerage and transaction charges, and it’s essential to consider this cost while calculating returns.
Should You Invest in NCDs Now?
With interest rates expected to decline in the future, investing in high-yield NCDs from reputable companies could be a smart move for those looking to lock in attractive returns. According to Deepak Jasani, Head of Research at HDFC Securities, NCDs are particularly beneficial for investors who want liquidity and flexibility in withdrawing funds when needed. Additionally, with the current economic trends, NCDs could outperform traditional savings options like FDs, especially for investors looking to diversify their portfolios with low-risk debt instruments.
While NCDs do offer higher returns, it’s essential to carefully assess the issuing company’s credit rating and liquidity before making any investment.
