Improve your returns with NCDs

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With small savings rates, as well as, bank fixed deposit (FD) rates coming under pressure, the risk-averse investor would be seeking debt products that offer slightly higher rates. The good news is that non-banking finance companies (NBFCs) are once again lining up non-convertible debenture (NCD) issues. They are expected to offer retail investors 1.5-2.75 per cent higher interest rates than the State Bank of India’s long-term fixed deposit rate, currently at 6.25 per cent.


In July, Mahindra & Mahindra Financial Services and Srei Equipment Finance are expected to hit the market with their NCD issues. Being backed by a large corporate house, Mahindra Financial NCD would be priced between 7.5-8 per cent, said investment banking sources. Srei Equipment Finance’s offering is expected to be around 8.5-9 per cent. Two Tata group companies are also expected to follow the two issues.


Wealth managers are quite enthused with these rates. “Retail investors can put a portion of their debt portfolio in high-rated papers, but they need to select companies which have a good record of repayment,” says Shankar Raman, CIO – third part products, Centrum Wealth Management. The advice for investors in bank fixed deposits is: spread your investments over multiple issues to cut down credit risk.


With returns on fixed deposit coming down sharply, investors are lapping up NCDs. Some of the earlier issues were oversubscribed on the very first day of opening. For example, the Rs 2,000 crore Muthoot Finance NCD, which opened on April 11, closed the very next day. It had allocated as much as 60 per cent of the issue for high net worth individuals and retail investors.    


However, investment managers point out that both instruments – FD and NCD – are not strictly comparable though both offer fixed returns. The latter carries more risks than FDs and therefore, offers higher returns. “A public bond issue requires much more compliances compared to those offered only to institutions. The final approval is given by the Securities and Exchange Board of India after detailed scrutiny,” says Ajay Manglunia, executive vice president at Edelweiss Finance.


Source: Sebi prospectus
If your debt portfolio is not large, invest it in four-five issues over the year. An investor should ideally spread investments across 8-10 issues, say investment managers. Those who set aside money every month for investment or don’t have the risk appetite, can look at five-year fixed deposits from India Post, which offers 7.7 per cent interest rate. Unlike stocks, where brokerages track and publish detailed research reports, NCDs require an investor to do the necessary homework.


Also, remember that it is important to hold these NCDs for the entire tenure. “All bonds get listed nowadays. But there’s a lack of liquidity in the secondary market for NCDs,” says Raman. He points out that tax-free bonds that came in 2015 and perpetual bonds have more demand on stock exchanges than supply. Many wealthy don’t prefer NCDs due to liquidity issues.


For ones seeking more liquidity, mutual funds are a better option. Debt mutual funds hold a variety of paper that reduced risk in the overall portfolio. They can be redeemed in two working days. If held for over three years, debt mutual funds are taxed at 20 per cent after taking cost inflation index into consideration. The tax outgo, in this case, reduces significantly. Bonds are taxed just like FDs and so are debt mutual funds held for less than three years. The gains are added to the income and taxed based on the investor's tax slab rate.


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