There have been multiple public issues of non-convertible debentures (NCDs) in the last two month. Presently, NCDs from Mahindra Finance and Shriram Transport Finance are open for grabs offering interest as high as 9.7 percent. These are fixed income instruments with high-interest rate but besides the high returns, there are some important factors that you need to consider.
Safety (credit ratings)
There are credit rating companies that rate debt instruments like NCDs based on historical data and future forecasts like defaults in payments in the past, years of business and the outlook for the company issuing it. It gives an indication of the probability that the company will default on its payment of interest or principal amount. The ratings come with a key that you can refer to. For example, a AAA could be the highest rating to be offered where the chances of a default in payment are very low. Usually, instruments rated AA or AAA are considered safe.
Note that for companies listed in emerging economies like India, the ratings can be volatile, which means the credit rating could go higher or lower anytime, leaving you no time to change your mind if you have already locked your money in the NCD. It is best to bet your money on established and cash-inflow-rich companies.
Unless a long term instrument is guaranteed by the government, it is risky to lock your money for a term as long as say 8 years.
NCDs come with the option to either receive payouts at intervals or accumulate all the interest to withdraw with the principal at maturity. The selection of the option and the tenure will depend upon your short term and long term goals in line with when you need the money. For example, if you want the NCD to be a source of long term debt allocation in your portfolio, you can choose to hold it till maturity.
If you are looking for a source of regular income, say monthly payouts, you can even choose an NCD from the secondary markets if the present options do not give you that option.
Interest payouts from NCDs are clubbed with taxable income. There is no tax exemption provision on company NCDs cutting down your interest earnings when they get credited to you, making the attractive returns (for example over 10 percent) not so high yielding. If you fall in the higher tax bracket, the tax cut would hurt more.
Some NCDs will not provide you the option to exit at any time and at a price that you want. Low liquidity of some NCDs makes it difficult to exit at a price that can fetch maximum returns. If you wish you invest in debt instruments with good returns and high liquidity, you can opt for debt mutual funds instead and some bonds listed on the exchanges.
However, if you have a long term plan ahead of you, NCDs provide you with a certainty of an amount to be received just like a fixed deposit as it promises a predictable return of capital invested and interest on maturity. If liquidity is not your concern, it should serve you well.
Note that it is best to hold the NCD till maturity whether you bought it at the public issue or the secondary market unless you have an expert that can help you sell at the right time to make high returns.