What are the Pros and Cons of Investing in NBFC NCDs?

Debentures, especially Non-Convertible Debentures (NCDs), are often neglected when it comes to investment plans. However, despite being relatively less important, they are quite important to businesses, especially ones looking to raise capital. Moreover, it is necessary to examine the complicated nature of non-convertible debentures (NCDs) and differentiate between the several kinds that are accessible. Thus, it is essential to clarify the pros and cons of investing in NCDs, to get through the complexity of the financial world.

Topics Covered:

• NCDS (Non-Convertible Debentures) Meaning
• NCDS Types
• Advantages of investing in NCDs
• Disadvantages of investments in NCDs
• Conclusion

NCDS (Non-Convertible Debentures) Meaning

Debentures are a less familiar investment option which is yet to be discovered by many individuals. However, despite being neglected by many, it plays a very crucial role in a company’s capital-raising endeavours. Non-convertible debentures (NCDs) are also common forms of debentures, which are issued by companies for their financial needs. Unlike convertible debentures, NCDs can’t be changed to equity shares. These are unsecured assets which lack support from companies. Investors who invest in NCD rely on the company’s creditworthiness, with due diligence when conducting investment research.

Similar to convertible debentures, NCDs also offer fixed interest rates, which are coupon rates, often determined by the issuing company upon issuance. Interest is disbursed to investors at regular intervals, such as monthly, quarterly, semi-annually, or annually. It is based on the signed agreement between the issuer and the subscriber. This is one of the major benefits of NCDs. Additionally, NCDs have a fixed maturity period. Upon maturity, investors get principal investment and also get interest accumulated over the period.

While NCDs offer a steady income stream and defined maturity terms, investors should carefully evaluate the issuing company’s financial health and creditworthiness.

Read Also: Basics of Stock Market

NCDS Types

Non-convertible debentures (NCDs) come in two main types: Secured NCDs and Unsecured NCDs, each with distinct characteristics and risk profiles.

Secured NCDs

Secured NCDs are considered the safer option as they are backed by the company’s assets. In the event of non-payment of interest, investors can reclaim their dues by liquidating the company’s assets. However, the trade-off for this safety net is lower interest rates compared to unsecured NCDs.

Unsecured NCDs

On the other hand, Unsecured NCDs pose a higher risk as they lack backing from company assets. In case of default, investors have limited recourse and may have to wait for payments. Despite this risk, unsecured NCDs offer higher interest rates compared to their secured counterparts, making them attractive to investors seeking greater returns.

Investors must carefully weigh the risk-return ratio when considering between secured and unsecured NCDs. The differences between these two types of NCDs are essential for investors to make informed decisions.

Read Also: What is a Demat Account?

Advantages of investing in NCDs

Non-convertible debentures (NCDs) come with several advantages making it an attractive investment option for investors. This is a good option for those, who are seeking higher returns and liquidity.

Let’s look at some of the major advantages of NCDs:

• Safety on Assets: The unsecured  NCDs also carry a priority charge on the assets of the company, providing investors with a sense of security. When defaulted, NCD holders have precedence over equity shareholders, which makes their NCD investment safer.
• More Earnings: NCDs typically provide higher interest rates when compared to traditional investment avenues, including bank Fixed Deposits (FDs), government bonds, or securities. This is an appealing option for investors who want better and good returns.
• No Tax Deduction: Interest earned through NCDs is not subject to Tax Deducted at Source (TDS), which comes with tax benefits for investors.  However, the interest earned is taxable at the investor’s slab rate.
• Secure Investment: Before issuing NCDs, there are creditworthiness reviews, which most of the companies undertake, by competent credit rating agencies. It is then regulated by the Reserve Bank of India (RBI). This enhances investor confidence in the company’s financial stability and future prospects.
• Easy Trading: Listed NCDs can be traded in the open market with the help of an online demat account, providing investors with liquidity and the opportunity for capital appreciation. This flexibility is a major benefit of NCDs that allows investors to buy and sell NCDs as per their investment goals and market conditions.

Disadvantages of investments in NCDs

Non-convertible debentures (NCDs) offer attractive benefits, but they also come with certain limitations that investors should consider. Here are the major disadvantages of NCDs:

• Taxation Impact: The returns from NCDs are subject to taxation, leading to potentially lower post-tax returns compared to other debt investment options like debt mutual funds or hybrid mutual funds.
• Potential for Lower-Quality Issuers: There’s a possibility that lesser-sound companies with lower credit ratings may issue NCDs. These companies pose a higher risk of default, potentially resulting in investors not receiving the principal amount and accrued interest upon maturity.
• Fixed Interest Rates: NCDs provide fixed returns, meaning that they don’t account for inflation. Consequently, post-inflation returns from NCDs might not be as appealing as those which come from other dynamic investment options available in the market.
• Inability to Convert to Equity Shares: Unlike convertible debentures, NCDs cannot be converted into equity shares. With this, there is a restriction for investors as they can’t become shareholders of the issuing company in the future, as they miss out on the potential of better returns.

Considering these limitations investors need to evaluate the whole plan, especially the risk-return profile of NCDs. Furthermore, investors should also make sure that they open a demat account and that the investments align with their investment objectives and risk tolerance.

Conclusion

For investors, non-convertible debentures (NCDs) are considered to be an appealing mix of NCDS advantages and disadvantages. Despite benefits which can’t be overlooked, including more liquidity as well as larger returns, there are certain drawbacks and restrictions which might result in huge losses, which should be carefully considered. Investors should carefully conduct detailed research on these aspects in relation to their investment goals and risk tolerance.