NCDs may offer a higher interest rate than fixed deposits but experts advise caution

• Typically, a non-convertible debenture carries a fixed interest rate that has an inverse relationship to how credit worthy the borrower is.
  
• NCDs are more liquid than corporate FD as they are traded in the secondary market on stock exchanges.
  
• Each NCD undergoes assessment by multiple credit rating agencies, portraying the issuer's capacity to honour payment commitments.
  

A non-convertible debenture, (NCD), is a type of debt instrument that lacks the option for buyers to convert it into shares or equities until its maturity. When investing in an NCD, buyers have the choice to purchase or sell the instrument and receive interest payments determined by the issuer's fixed interest rate.

“But they are more liquid than corporate FD as NCDs are traded in the secondary market on stock exchanges,” says Abhishek Kumar, founder and chief investment advisor at SahajMoney, a financial planning firm.

Interest rate: Typically, a non-convertible debenture carries a fixed interest rate that has an inverse relationship to how credit worthy the borrower is. An NCD from a highly rated issuer tends to offer a lower interest rate.

Credit rating: Each NCD undergoes assessment by multiple credit rating agencies, portraying the issuer's capacity to honour payment commitments. Strong financials and a healthy cash flow of the issuing company result in higher ratings for the issued NCD.

Should you invest?

One should be very clear about the quality of the NCD, what is the cash flow of the company and what is the risk one is going to take. One should consider the credit rating of these NCDs before investing. However, that may not be foolproof.

Do not invest in NCDs just for higher returns

Investing in NCDs may not be a good idea, even if you are going with a AAA rating, say experts.

Certain NCDs have left a bad taste in the mouth off late. One example is that of the default of the Dewan Housing Finance Corporation Ltd (DHFL) NCD which was AAA rated but was offering a higher interest rate than some AAA rated NCDs. Same was the case with Infrastructure Leasing & Financial Services Limited (IL&FS), whose NCS was also AAA rated.

“Even HDFC has a AAA rating , why should someone have to pay you more than the other? So, there is a perceived risk in the NCD which is offering higher returns” says Srinivasan, director and founder, Shree Sidvin Investment Advisors.

Numerous NCDs are now being offered at attractive yields as a result of the increase in interest rates. “However, one should be well informed about the company in which they want to invest, and they shouldn't base their investment decision solely on the basis of the high yields,” says Raghvendra Nath, MD, Ladderup Wealth Management.

So higher interest rates of 9% or so should not be a reason to invest in NCDs. “We do tell our clients that for a difference of 2-3% in interest rate you should not take a principal risk,” says Srinivasan.

Thus, when investing in NCDs, it pays to be careful.