Higher return from NCDs come with higher risk

Diversify across bonds of 4 or 5 firms

Is it a good idea to lock into non-convertible debentures (NCD) offering higher yields, given that interest rates are likely to move downwards? Gold loan company Muthoot Finance’s NCD issuance is open to subscription till October 7. The non-banking financial company (NBFC) is offering between 9.5 and 10.25 per cent to retail investors, on secured NCDs for tenors ranging from one to five years. Unsecured NCDs have a tenure of 84 months with a coupon rate ranging from 9.66 to 10.41 per cent.

In comparison, the interest rates on bank fixed deposits (FDs) for one to five years is between 7.25 and eight per cent. In the case of income funds, the five-year return is 8.7 per cent. In the case of debt investments, investors must always look at the safety of the instrument. Therefore, one must look at the credit worthiness of the NCD. Any bond that is rated lower than ‘AAA’ tends to be risky, says Anil Rego, chief executive officer of Right Horizons.

In the case of Muthoot Finance’s NCD, the rating is ‘AA-’ from ICRA, which is why coupon rates are high.

“Ideally, one should not hold more than five-eight per cent of the total portfolio in NCDs. That, too, should be spread over four-to-five companies. The only advantage is the higher coupon rate these offer compared to FDs. Hence, they appeal to retired people, but it is not advisable to invest retirement savings in NCDs,” says Rego. Another way of achieving automatic diversification is by investing in corporate bond mutual funds, Rego adds.

Muthoot is offering both secured and unsecured NCDs. The difference is that in the case of secured NCDs, investors can get back some amount of the principal and interest if there is a default, since there is an underlying collateral. But in case of unsecured NCDS, there is no collateral. That is why Raghavendra Nath, managing director of Ladderup Wealth Management, advises that investors can look at tenure of five-to-seven years in case of secured NCDs, but in the case of unsecured NCDs, it should be restricted to two-to-three years. “One can look at investing small monies in the issue. Although Muthoot is in the gold lending business, it has survived the fall in gold prices and regulatory changes. Besides, its loan book is granular and largely lends to retail customers. So, recovery rates are good and the loans are adequately collateralised,” he says. However, according to Feroze Azeez, deputy CEO of Anand Rathi Private Wealth Management, the company is facing business uncertainty due to regulatory changes, especially after the gold monetisation scheme has been permitted. “The number of people seeking gold loans may come down as they may prefer monetising their gold. Also, the business is skewed towards a single asset, which makes it even more uncertain.”

Instead of investing in NCDs for higher rates, it is advisable to wait for tax-free bonds that are likely to hit the market by November, says certified financial planner Arnav Pandya. These are safer as they have higher ratings, offer longer-term investment and are tax-efficient. In case of NCDs, the interest is taxed. The latest guideline by the Securities and Exchange Board of India (Sebi) asking NBFCs to issue detailed disclosures while launching a public offer will definitely bring in more transparency. But this will happen only over a period of time. “As of now, the transparency for NBFCs is low vis-a-vis the banking system. But for the Sebi guideline to have a tangible benefit, it will take time,” says Azeez.