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Thursday, August 11, 2016

Non-Convertible Debentures Vs Corporate FDs

The Bank FD interest rates have fallen off late. With the government pegging the inflation target to 4%, they are likely to fall further. At this point, it does make sense to look at other options which are of similar nature as FDs ie Corporate FDs and NCDs (Non Convertible Debentures)...Read on...

Unlike western countries, in India, investment in non-convertible debentures or bonds by retail investor is very low. There are very few high net worth individuals or retail investors who participate in bond market and they earn a handsome return on their investments. One of the main reason for low participation is lack of knowledge and awareness.
To get the initial understanding of Debentures and their different types, read here: What are Debentures?

There are a few things that are common across NCDs and Corporate FDs like both of them are issued by companies or NBFCs and not Banks. However, there are clear and distinct advantages of investing in NCDs v/s Bank/Corporate Deposits. Let us analyze the differences in the two types of Debt based investments category wise:

Returns
Since the NCDs / Bonds are listed and traded regularly on the exchange, it gives an opportunity to even trade and earn profit. Thus you have a chance to earn capital appreciation on your invested amount, over and above the interest yield. You have no such opportunity in a Corporate FD. The prices of bonds increase, when the interest rate in the economy starts softening. In the current scenario, this is exactly where we are headed.  
In general, you would get 1-1.5% higher yield through a NCD than you would through a Corporate FD.

Liquidity
Though the NCDs usually have a larger time horizon as compared to Corporate FDs, they are still more liquid. NCD or Bonds are in demat form, and therefore there is no hassle of maintaining and safe keeping of physical certificates. This also makes them more easily trad-able, therefore adding Liquidity to your portfolio. All the bonds issued under public offer are listed on BSE/NSE, thus there is no lock in period. The investor can exit anytime before the maturity.  However, sometimes, liquidity on the exchange can be poor.
And remember that Liquidity in your portfolio is a key aspect of your portfolio. Read here why? --> Liquidity is a Vital Aspect of Your Portfolio

Taxation
There is no TDS (Tax Deduction at Source) deduction in case of NCDs / Bonds since they are in demat form and are listed. Therefore, there is no hassle of filing form 15G/H. Want to know more on Tax Free Bonds? --> Read here : Tax Free Bonds in India
Moreover, the investment in NCDs beyond one year will be considered as long term. And the profit earned on sale will be taxed at 10.30% (without indexation). If you compare this with Company FDs, you are taxed as per your current tax slab, which could be as high as 30%


Reinvestment Risk
The tenure of bonds can range from less than one year to 30 years. Thus it works as a buffer against reinvestment risk and at the same time offers steady source of interest income.
An investor who is selling the bonds before the maturity of the bond gets accrued interest till the date of the sale.

Safety
Corporate FDs can be generally termed to be of 'Medium' safety since a lot depends on the financial strength of the specific corporate issuing the Fixed Deposit, its rating etc. The NCDs are generally more secure in nature, especially if you go for NCDs which are 'Secured' rather than 'Unsecured' (Read here on Debenture types). Secured Debentures are usually secured against the company assets. Though NCDs are unrated, they are believed to be more secure as compared to Company FDs. However, do not go blindly in the lure of higher yield. Look for at least AA credit rating of the company issuing NCD.

Summary
NCDs do have many advantages over Corporate FDs, but do not get blindly lured away. Look for a decent enough credit rating of the issuer before jumping in.

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Cheers

Manoj Arora
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