NCDs Vs FDs: Which Is A Better Investment Option And Why?

Small investors who are keen to make hay during the rising financial markets, but lack the risk appetite, can, and in fact should, park their money in the corporate debt instruments instead of bank fixed deposits. These debt instruments, also known as Non-Convertible Debentures (NCDs) are attractive investment options for the higher rate of interest that they offer, risk-free nature and tradability. The non-convertible debentures (NCDs) are essentially the loans raised by corporate entities from the public. Government loans are known as bonds, while the corporate ones are known as debentures. Since these debentures (loans) are not allowed to be converted into equity at a later stage, they are prefixed with "non-convertible" before their name.

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Since the instruments are tradable in the financial markets, the investors can buy them at a later stage from the secondary market. Another feature that distinguishes them from the fixed deposits (FDs) is that the rate of interest on NCDs is relatively higher than that of the fixed deposits.

"All other things remaining constant, NCDs offer greater liquidity and if secured, they offer safety thereby giving the investor a better investment avenue," said Killol Pandya, head, fixed income, Essel Mutual Fund.

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NCDs Vs FDs

NCDs and Bank fixed deposits (FDs) are both popular investment options for retail fixed income investors. An NCD is a type of loan that is issued by a company, which cannot be converted to equity. They are higher risk in nature when compared to a bank fixed deposits, since they run the risk of the issuer defaulting on repayments. Secured NCDs are safer than unsecured ones, but offer higher returns as well. Since risk and rewards go hand in hand, NCDs typically offer 200-250 basis point higher returns than the bank FDs at any point in time. "Retail investors with a lesser than average understanding of bond markets may be better off investing into Mutual Fund FMP's (Fixed Maturity Plans) instead of NCD's," said Mayank Bhatnagar, COO, FinEdge. 

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Liquidity

The sceptics believe that the NCDs suffer from a disadvantage that they are not liquid, because of which, they are not reliable for the small investors. However, not all agree to this.

"Liquidity of NCDs is a function of several factors including the quality of the instrument (rating), the availability of the instrument (liquidity) and other market-related factors, such as interest rates etc. NCDs can be traded on exchanges where they are listed or in the telephonic market. Several NCDs are extremely liquid and are freely traded in the markets," added Killol Pandya.

This means the NCDs with AAA rating are the most liquid, and the ones with AA+ rating are expected to be relatively less liquid. Likewise, the NCDs with AA- rating would be less liquid when compared with the AA+ rating debentures.

Apart from the ratings, there are other factors also that influence the liquidity of NCDs.

When the interest rates are on an upswing, some of these instruments might find it hard to liquidate at reasonable prices. In rising interest rate scenario, investors may end up selling their NCDs at a discount to their face value. "The liquidity of your NCD would really depend upon how interest rates have moved after you invested," added Mr Bhatnagar.

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Factors to consider before you buy

One must consider some factors before investing in the NCDs. "The factors include the quality of the issuer (rating), financial strength and stability of the issuer, tenure or residual maturity of the instrument, value one is getting for the NCD (Yield or YTM) and the liquidity," said Killol Pandya, head, fixed income, Essel Mutual Fund.

The above are instrument related factors which should be analysed together with market related factors such as interest rate scenario and outlook, market liquidity situation and outlook, added Pandya.

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Safe NCDs

There are several safe non-convertible debentures (NCD) options which are rated highly by the credit rating agencies, such as CRISIL, CARE and ICRA. Reliance Industries (RIL), L&T and HDFC are a few heavyweight names.

"Often, NCDs are not issued to the general public, but offered to a specific group of people. A case in point is HDFC's Rs 2,000 crore NCD issue last year, which was open for subscription only to a specifically addressed group. Typically, a AAA rated NCD can be expected to carry a coupon of 8-8.5% in today's scenario, although these numbers may change in tandem with moving bond yields," said Mayank Bhatnagar, COO, FinEdge.