Spread your risk by investing in NCDs; go for issues rated AA and above

A slew of non-convertible debenture (NCD) offerings have hit the market recently, such as Muthoot Finance, Indiabulls Consumer Finance, Mahindra Finance, Mannapuram Finance and Shriram Transport Finance. 

More firms may come out with such issues to finance their capital requirement. And there is a good chance your financial advisor may advise you to invest in these. 

“Certain well-rated NCDs are offering as high as 200 basis points premium in terms of interest rates, when compared to fixed deposits (FDs) at prevailing rates, which make them a lucrative investment option,” says Rahul Parikh, CEO of Bajaj Capital.

Since the lure of a higher rate is there, the question is — how should you analyse these products? 

Jaikishan Parmar, senior equity research analyst (BFSI), Angel Broking, feels investors can consider putting money in NCDs, given the likely lowering of interest rates by the Reserve Bank of India (RBI). 

“Non-banking financial companies are currently paying anywhere in the range of 10-12 per cent for unsecured NCDs and slightly lower for secured NCDs. It provides a good opportunity to lock in your money at higher yields at a time when the RBI has hinted at dovish rates,” says Parmar.

However, with higher yields come higher risks. Unlike bank FDs that are considered risk-free investments, NCDs do carry a certain amount of risk. Primary among them is the risk of default, either servicing the interest payment or meeting their principal repayment obligations.

“One of the critical risks of investing in NCDs is the chance of default in payment. Recently, a well-known infrastructure conglomerate defaulted on payments to NCD investors. At the time of investing, the credit rating of the instrument may look good, but if the financial condition of the issuer is not strong or deteriorates in future, the investor’s risk automatically increases,” warns Adhil Shetty, CEO of BankBazaar. 

Before investing check these parameters:

Credit ratings: Checking the issuer’s rating is a must. It is an indicator of the firm’s ability to meet repayment obligations. The ratings are given by rating agencies like CRISIL, CARE, or Icra.  “Low-rated NCDs may offer you a high return, but the default risk is higher. Avoid investing in such NCDs in greed of earning a high return,” says Shetty. Any rating equal and above AA can be considered for investing. However, you should ideally go for AAA-rated NCDs.

Interest rate movement: You should ask yourself whether rates likely to go up or go down or speak to your financial advisor. Investing in NCDs makes more sense when interest rates are moving southwards.

NCD tenure: Companies offer different tenure options depending on their NCD issue. You should choose the tenure basis your requirements. Ideally, avoid investing in NCDs for the short term because you may find it difficult to exit if there are liquidity issues in the secondary market at that time.

Payout options: You can either go with a monthly, quarterly or yearly payment option, according to your needs. However, instead of a monthly payout option, you should go for the cumulative returns option as that can fetch you higher returns.

Past repayment record: You should go through the NCD offer document and also check the past debt servicing track record of the issuer. “If there have been defaults in the past, then such NCDs are best avoided. Further, be wary of NCDs in case the leverage of the company is too high,” says Parmar.