Non convertible debentures(NCDs) are back in season. With the fall in the interest rate of traditional deposits over the years, NCDS have become favourite investment options among investors. As a result, many companies have come up with public issue of non convertible debentures.
Non convertible debentures are fixed income(debt) securities that can’t be converted into equities. Companies issue NCDs to raise funds from the public. However, not all NCDs are available to the public as a majority of the NCDs are only available for institutional investors and are not available to retail investors. Hence, the public issue of NCDs are oversubscribed within a few days.
As NCD is a fixed income instrument like fixed deposits, NCDs are considered as an alternative to fixed deposits. Let’s see how NCDs and FDs are placed against each other.
Returns: The non convertible debentures fetch higher returns than fixed deposits. Currently, the public issue of secured redeemable non convertible debentures (NCDs) of ECL Finance, the NBFC arm of the Edelweiss Group is open for subscription till June 7,2019. It offers the highest interest rate of 10.42% for 120-month tenure i.e. for 10 years. The interest rate for five-years is 10.42% p.a. On an average, NCDs give returns around 10%-11%. On the other hand, fixed deposits offer lower interest rate. The average interest rate of FD is 6-7% p.a. Few small banks offer interest rate of up to 8.25%.
NCDs give higher interest rate than FDs but it also comes with higher risk. This brings us to the second point.
Non convertible debentures are riskier than fixed deposits. NCDs can be categorised with two types: secured and unsecured. A secured debenture is secured by a set of assets while an unsecured debenture is not secured by any charge on the assets of the company. Hence, secured debentures are more unsecured debentures. To compensate for the risk, unsecured NCDs offer a slightly higher return than secured NCDs. Credit rating agencies assign rating to the various issue to ascertain the credit worthiness (the ability to pay the principal and interest) of the issuer company.
On the other hand, bank deposits of up to Rs.1 lakh are insured under the Deposit Insurance and Credit Guarantee Corporation (DICGC). As of date, the Reserve Bank of India has not allowed any bank to deny the claims by their customers. This is an extreme situation and most banks are big enough to fail and hence it is unlikely that banks will default on their deposits.
Fixed deposits score over NCDs in this respect. It is because fixed deposits come with different maturity period from seven days to 10 years while NCDs have a set of maturity period that generally starts from two years to ten years. E.g. the tenures of the NCD of ECL Finance are 24 months, 39 months, 60 months, and 120 months. Hence, only invest in NCDs when you are totally sure that you will hold the paper for the entire tenure. If not, fixed deposits are the better alternatives. It is because the liquidity of the NCDs in the secondary market is very low.
Liquidity: Fixed deposits are more liquid than NCDs. Although NCDs can be traded in secondary market, there is little demand for these NCDs on the secondary market. Hence, it is not a seamless process for individual investors. In case of fixed deposits, fixed deposits can be easily liquidated. If you want break your fixed deposits before the maturity date, you just need to pay a penalty and your money will be credited to your savings account within a few minutes.
NCDs may be alluring as it gives higher returns. However, it will be wiser to compare the various features of both the investment options before investing.
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