Both Non Convertible Debentures (NCDs) and Company Fixed Deposits (FDs) involve investing
(a) your money with a company
(b) to earn fixed returns.
Hence, as far as the essence of the two products is concerned, both are same.
However, the operational parameters are different:
It is these 'technical' differences that give Non Convertible Debentures an edge over the Company Fixed Deposits.
One. FD is unsecured. But NCD can be secured. So, a secured NCD is better than FD.
Two. NCD is listed. Though trading may be thin, you still have some liquidity option. Pre-mature closure of FD is relatively more difficult and time consuming.
Three. There is no penalty on selling your NCD prematurely. Pre-mature closure of FD attracts penalty.
Four. Partially selling your NCD is possible. But FD does not have facility of partial withdrawal.
Five. NCD (in demat form and listed) has no TDS. For FD, TDS is applicable if interest > Rs.5000 p.a.
Six. If the interest rate movement is favourable, you can also earn capital appreciation in NCD. (Likewise, your NCDs may also depreciate; but then you can avoid this depreciation by holding your NCDs till maturity.)
Seven. Normally FD is of shorter tenure (1-3 years) than NCD (3-5 years). As such, the NCD interest rate may possibly be higher than FD rate.
Warning: Having said that, Investing in a company (whether by way of NCD or FD) is risky...very risky.
Therefore, you must exercise extensive due diligence and extreme caution before investing in any company.
Why investing in NCDs is not a good idea?
1. Non Convertible Debentures are very risky.
When investing in NCDs you are taking a risk on the borrowing company. If the company faces financial difficulties, it may default on its commitment to pay you interest or even repay your principal. Historically, it has been seen that this risk of default is quite high.
Therefore, I would sincerely advise you not to take this high risk for a mere 2-3% additional returns. The risk-reward ratio is definitely not favourable. With the economy not in a good shape, many companies are already experiencing difficulties.
2. Non Convertible Debentures are illiquid.
Even though they are listed on the stock exchange, the trading in NCDs is very minimal. Therefore, you may find it very difficult to withdraw / sell your investment prematurely. Even if you do find a buyer, you may have to off-load your investment at a steep discount.
As such, be very sure that you won't need this money before maturity.
3. Non Convertible Debentures are taxable.
Interest income from NCDs will be added to your income and taxed as per your slab rate. Therefore, even if the coupon rate may be high at 12-13%, the effective post-tax returns from NCDs would be around 8.5-9% (if you are in the 30% tax bracket).
As such, it may be prudent to invest in debt MFs where you may still make 7.5-8.5% post-tax returns with very low risk and very high liquidity.
A Different Alternative
Personally, I would rather take risk in equity of a company with safe financial parameters, rather than NCD of a company with risky financial parameters. As such I would prefer investing in MIP scheme of a Mutual Fund (which invests 85-90% in debt instruments with balance 10-15% in a diversified equity portfolio). This, I believe, would give similar kinds of returns as a non-convertible debenture, but with reasonably lower risk, much higher liquidity and better tax efficiency.
(a) your money with a company
(b) to earn fixed returns.
Hence, as far as the essence of the two products is concerned, both are same.
However, the operational parameters are different:
It is these 'technical' differences that give Non Convertible Debentures an edge over the Company Fixed Deposits.
One. FD is unsecured. But NCD can be secured. So, a secured NCD is better than FD.
Two. NCD is listed. Though trading may be thin, you still have some liquidity option. Pre-mature closure of FD is relatively more difficult and time consuming.
Three. There is no penalty on selling your NCD prematurely. Pre-mature closure of FD attracts penalty.
Four. Partially selling your NCD is possible. But FD does not have facility of partial withdrawal.
Five. NCD (in demat form and listed) has no TDS. For FD, TDS is applicable if interest > Rs.5000 p.a.
Six. If the interest rate movement is favourable, you can also earn capital appreciation in NCD. (Likewise, your NCDs may also depreciate; but then you can avoid this depreciation by holding your NCDs till maturity.)
Seven. Normally FD is of shorter tenure (1-3 years) than NCD (3-5 years). As such, the NCD interest rate may possibly be higher than FD rate.
Warning: Having said that, Investing in a company (whether by way of NCD or FD) is risky...very risky.
Therefore, you must exercise extensive due diligence and extreme caution before investing in any company.
Why investing in NCDs is not a good idea?
1. Non Convertible Debentures are very risky.
When investing in NCDs you are taking a risk on the borrowing company. If the company faces financial difficulties, it may default on its commitment to pay you interest or even repay your principal. Historically, it has been seen that this risk of default is quite high.
Therefore, I would sincerely advise you not to take this high risk for a mere 2-3% additional returns. The risk-reward ratio is definitely not favourable. With the economy not in a good shape, many companies are already experiencing difficulties.
2. Non Convertible Debentures are illiquid.
Even though they are listed on the stock exchange, the trading in NCDs is very minimal. Therefore, you may find it very difficult to withdraw / sell your investment prematurely. Even if you do find a buyer, you may have to off-load your investment at a steep discount.
As such, be very sure that you won't need this money before maturity.
3. Non Convertible Debentures are taxable.
Interest income from NCDs will be added to your income and taxed as per your slab rate. Therefore, even if the coupon rate may be high at 12-13%, the effective post-tax returns from NCDs would be around 8.5-9% (if you are in the 30% tax bracket).
As such, it may be prudent to invest in debt MFs where you may still make 7.5-8.5% post-tax returns with very low risk and very high liquidity.
A Different Alternative
Personally, I would rather take risk in equity of a company with safe financial parameters, rather than NCD of a company with risky financial parameters. As such I would prefer investing in MIP scheme of a Mutual Fund (which invests 85-90% in debt instruments with balance 10-15% in a diversified equity portfolio). This, I believe, would give similar kinds of returns as a non-convertible debenture, but with reasonably lower risk, much higher liquidity and better tax efficiency.
