Why NCDs are better than bank FDs if you're looking for higher returns

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Investors looking for higher returns than those offered by bank fixed deposits may consider investing in non-convertible debentures (NCDs). Around Rs 185 billion worth of NCDs are slated to hit the markets or are currently open for subscription. These include offerings from players like Tata Capital Financial Services, Aadhar Housing Finance, and so on.

The primary advantage of investing in NCDs is that they usually offer higher rates of interest than bank fixed deposits (FDs). "They are currently offering an interest rate of around 9-9.5 per cent, while bank FDs mostly offer rates in the range of below 8 per cent," says Abhinav Angirish, founder, investonline.in.  

NCDs come with a few risks as well. "The key risk in an NCD is that you are betting your money on a single company," says Anil Rego, chief executive officer, Right Horizons. The second risk pertains to liquidity on the exchanges. If trading volumes in an NCD are thin or non-existent, investors may find it difficult to exit it mid-tenure, or they may have to compromise by selling at a discount. The level of liquidity in an NCD depends on the quality of the company. NCDs from good quality companies enjoy high demand, and hence finding buyers for them is not difficult. But poorer quality papers tend to have lower liquidity.

Before investing in an NCD, check its credit rating. "I would only invest in an NCD having a rating of AA+ or higher," says Rego. Investors should also check whether the NCD is secured or unsecured. The former type is backed by the assets of the company, which means that investors have less to worry about in case of a default.

Investors should also avoid overexposing themselves to NCDs, just because the interest rates are attractive. "Ideally if you are investing Rs 100 in debt, up to Rs 20 can be put in NCDs. This money should be spread among 5-10 companies. More money may be allocated to AAA NCDs, while the allocation to lower-rated papers should be less," says Rego.

In the current rising interest rate environment, investors need to compete with products like fixed maturity plans (FMPs) and short-term debt funds for investors' money. The key benefit of the latter is that they are diversified and the investor's money is spread across many papers. Moreover, open-ended funds are liquid. In the case of FMPs, again, they are listed and liquidity depends on trading volumes on the exchanges.