NCDs Explained: How They Work, Returns, Risks & Who Should Invest
If you've been looking beyond fixed deposits and mutual funds for investment options, you may have come across the term NCD. It sounds technical, but it's actually a fairly straightforward concept once you break it down. This article explains what NCDs are, how they work, their benefits and risks, and whether they're the right fit for your portfolio.
What is an NCD?
An NCD, or Non-Convertible Debenture, is essentially a loan you give to a company. In return, the company pays you interest regularly, say monthly, quarterly, half-yearly, or annually. When the NCD reaches its maturity date, you receive back the money you originally invested, along with any final interest payment.
The keyword here is "non-convertible." Unlike convertible debentures, which give the holder an option to convert them into shares of the issuing company after a certain period, NCDs cannot be converted into equity shares at a future date. This means you remain a lender to the company and not a shareholder.
Companies issue NCDs to raise capital for business needs, such as building factories or expanding operations. In India, NCDs are regulated by the Securities and Exchange Board of India (SEBI), which ensures companies follow rules to protect investors. A Debenture Trustee, appointed by the company, also watches over the process to ensure investors are treated fairly.
Types of NCDs
There are mainly two types of NCDs, which are discussed below.
Secured NCDs: Secured NCDs are backed by the issuer's assets, which serve as collateral. If the company defaults, investors can recoup their investment by selling these assets, thereby reducing risk.
Unsecured NCDs: Unsecured NCDs have no collateral backing and depend solely on the issuer's creditworthiness. They carry a higher risk but typically offer higher interest rates compared to secured NCDs.
There's also a distinction based on how interest is paid:
Cumulative NCDs: Interest accumulates and is paid along with the principal at maturity — good for those who don't need a regular income now but want a bigger payout later.
Non-Cumulative NCDs: Interest is paid at regular intervals. Better suited for those who want a periodic income.
NCDs vs FDs: The Return Difference in Real Numbers
One of the biggest reasons investors consider NCDs is the return advantage over traditional fixed deposits. To understand this better, let's look at a simple example.
Suppose you invest ₹5 lakh for 3 years. A large bank FD might offer you around 7% per annum, giving you approximately ₹1,10,250 in interest over the full tenure, bringing your total to ₹6,10,250 at maturity.
Now, if you invest the same ₹5 lakh in a well-rated NCD from an NBFC or corporate issuer for the same 3-year period at 9.5% per annum, your interest earned would be approximately ₹1,54,575 — a difference of nearly ₹44,000 over just three years.
That gap widens further if you choose NCDs with monthly compounding or reinvest the interest payouts. Of course, this comes with the caveat that unlike bank FDs, NCDs are not covered by the Deposit Insurance and Credit Guarantee Corporation (DICGC), which insures bank deposits up to ₹5 lakh. So the higher return does come with a corresponding degree of credit risk, which is why checking the issuer's credit rating is essential.
How Do You Invest in NCDs?
Investing in NCDs is simpler than most people think. Here's a step-by-step breakdown:
Step 1 — Open a Demat Account. All NCDs in India are issued and traded in demat form only. If you don't already have one, you'll need to open a demat and trading account with a registered broker or platform such as Zerodha, Groww, or any SEBI-registered depository participant.
Step 2 — Watch for NCD Public Issues Companies periodically open NCD subscriptions to the public, called public issues or NCD IPOs. These are announced on the SEBI website, stock exchange portals (NSE/BSE), and financial news platforms. The issue stays open for a limited number of days, during which you can apply.
Step 3 — Apply During the Issue Period You can apply through your broker's platform, net banking (via ASBA — Application Supported by Blocked Amount), or through your bank directly if they offer the facility. The minimum investment amount is typically ₹10,000 for most NCD issues.
Step 4 — Choose Your Series Most NCD issues come with multiple series, each offering a different tenure and interest payout frequency — monthly, quarterly, annual, or cumulative. Pick the one that best matches your income needs and investment horizon.
Step 5 — Buy from the Secondary Market (Optional) If you missed an NCD public issue, you can still buy it from the secondary market (NSE or BSE) through your broker, just like buying a share. Keep in mind that prices in the secondary market fluctuate based on interest rate movements and demand.
Step 6 — Hold Till Maturity or Exit Early. Once you own an NCD, you can either hold it till maturity to receive the full promised return or sell it on the exchange if you need liquidity before the tenure ends.
Benefits of Investing in NCDs
Here's why NCDs have been gaining popularity among retail investors in India:
1. Higher Returns than FDs: NCDs generally provide higher returns compared to traditional fixed-income instruments like bank fixed deposits. In a falling interest rate environment, this is a meaningful advantage.
2. Regular Income: You can choose when you want to receive your interest, that is, monthly, quarterly, or annually. This makes NCDs especially useful for retirees or anyone looking for a predictable income stream.
3. Liquidity: NCDs are actively traded in the stock market, which provides investors with the flexibility to buy or sell NCDs in the secondary market, enhancing liquidity and allowing investors to manage their portfolios dynamically.
4. Diversification: By investing in NCDs issued by different companies and industries, investors can reduce their risks significantly through diversification.
5. Put and Call Options (in some NCDs): A put option in an NCD means the investor has the option to surrender the NCD and get back the principal before maturity. This is extremely useful if interest rates rise and better opportunities appear elsewhere. A call option, on the other hand, gives the company the right to ask the investor to surrender the NCD in exchange for the principal.
Risks You Should Know About
NCDs are not completely risk-free, and here are a few of the risks to watch out for:
1. Credit Risk: NCDs are vulnerable to business risks. If the company borrows more than it can pay back, its credit rating will go down. So, always check the credit rating before investing.
2. Interest Rate Risk: If market interest rates rise, your NCD's market price might fall if you plan to exit early. Buyers prefer newer NCDs with higher payouts, so older ones may lose value in trading. But if you hold till maturity, none of that matters as you'll still get your promised returns.
3. Inflation Risk: When inflation climbs rapidly, the fixed interest from your NCD might lose its real value. The return that seems reasonable today may not keep up with rising living costs, so while your earnings stay the same, their purchasing power could quietly shrink.
4. Liquidity Risk NCDs often don't have enough buyers in the market (less liquidity), making sales tricky. If demand is low when you want to exit, you might have to settle for a discounted price. NCDs are better suited for those who can hold them till maturity.
How Are NCDs Taxed?
This is an important piece that many investors overlook. Interest on NCDs is taxed under the head 'other sources' at applicable slab rates. However, interest is not subject to tax deduction at source (TDS) if NCDs are held in dematerialised form and are listed on a stock exchange.
If NCDs are sold within a year, short-term capital gains (STCG) tax as per the income tax slab rate will be applicable. Long-term capital gains (LTCG) at 20% with indexation apply if NCDs are sold after a year but before the maturity date.
In short, if you hold NCDs till maturity, there's no TDS, but you'll still need to declare the interest income while filing your tax returns.
What to Check Before Investing
When choosing NCDs, pick companies with high credit ratings, such as AA or AAA, from agencies like CRISIL or CARE. Higher ratings mean the company is financially strong and less likely to default. Also, avoid companies with too much debt (more than 50% of their assets), as high debt means higher risk.
Also consider:
The tenure — does it align with your financial goals?
Whether it's secured or unsecured
The interest payout frequency that suits your cash flow needs
The issuing company's track record and reputation
Should You Invest in NCDs?
NCDs can be a smart addition to your portfolio if you are looking for better returns than a fixed deposit, prefer fixed and predictable income, and are comfortable holding the investment till maturity. They work best for conservative to moderate investors who want to diversify beyond FDs and government securities without taking on the volatility of equities.
However, if you need easy access to your money, or if you're investing in a company with a low credit rating, chasing higher interest, the risk may not be worth it.
So, in conclusion, NCDs are a useful tool, but like any investment, they reward those who do their homework before putting money in.
