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At a time when interest rates of bank deposits and small savings are dropping, investors will have to look at products that are offering higher returns, especially for the long-term.

Non-convertible debentures (NCDs) offered by companies are an ideal option for investors looking to park money in fixed income for the long term. One can invest in NCDs through the primary market when a company comes out with a public issue or from the stock exchanges after they are listed. Analysts say one should buy them when companies come out with public offer. Post-tax, the returns from NCDs are higher than bank term deposits.

M&M Financial Services

Non-banking financial company Mahindra & Mahindra Financial Services Ltd has launched NCDs (from July 10) to raise Rs 2,000 crore. Though the base issue size is Rs 250 crore, the company has an option to retain over-subscription of Rs 1,750 crore.

Retail individual investors will get an annual coupon of 7.85% on seven-year paper, 8% on 10-year paper and 8.05% for 15-year paper. The interest will be paid annually. The face value of a debenture is Rs 1,000 and subscription will close on July 28. For the 15-year paper, call option may be exercised by the company at the end of the 10th year from the date of allotment.

The bonds will be allotted to investors only in demat form. The minimum subscription amount is Rs 10,000. The allotment of the debentures will be done on first come first serve basis.

The unsecured NCDs have been rated AAA (outlook stable) by both India Ratings & Research and Brickwork Ratings, indicating highest degree of safety regarding timely servicing of financial obligations and and carry lowest credit risk. The company will use the funds from the NCD for onward lending, financing and refinancing the existing bonds of the company. The company came out with NCDs for the first time last year. Focused on rural and and semi-urban sector, the company has consolidated assets under management of Rs 54,000 crore as on March 31, 2017.

What to look for in NCDs

Before investing in NCDs, investors must see if they are secured or unsecured. In secured ones, they are backed by assets. Which means, if the company is unable to fulfil its obligations, the assets of the company will be liquidated to repay investors. On the other hand, unsecured ones are not backed by any assets. So, if the company is in financial trouble, there can be an issue in paying back the bond holders. As a result, unsecured NCDs pay higher coupons than secured ones.

While companies issue NCDs to raise long-term funds, these debentures cannot be converted into shares or equities. All NCDs issued have to rated and it is always advisable to buy those papers which have highest rating. Ideally, one should invest in NCDs till maturity for higher long-term returns and reduce the re-investment interest rate risk.

After maturity, the investor gets back the principal invested and the interest accumulated, if one opts for cumulative option. The company gets back its debenture. The listed debentures are treated as long-term capital assets if the non-convertible debentures are held for a period of 12 months. Investors must keep in mind that while NCDs offer good returns, they also carry higher default risks compared to bank or postal deposits. Moreover, they are very liquid unlike these deposits.

Companies do not deduct tax at source (TDS) on the interest earned every year if NCDs are held in demat form. In fact, any security issued by a company in a demat form and is listed on any recognised stock exchange in the country does not come under the TDS ambit. However, one has to declare the interest amount as income from other source at the time of filing tax returns and pay tax accordingly.

An investor should avoid investing over 25% of total portfolio in company fixed deposits or non-convertible debentures because of higher risk and poor liquidity as compared to bank deposits and debt mutual funds.

Last modified on Tuesday, 11 July 2017

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