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Tuesday, June 17, 2014

Investing in NCDs

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Investing in NCDs





Experts advise individuals to take a call on NCDs only after considering their ratings and post-tax returns, If a company goes bankrupt, secured NCD holders will be paid off first

Two non-convertible debenture (NCD) issues from Muthoot Finance and ECL Finance are available in the primary market. ECL Finance offers 12% for its 70-months NCD and Muthoot Finance offers tenures ranging from 24 to 75 months, with interest rates varying between 10.5% and 11.75%.


NCDs from Muthoot Finance have an AA rating, while ECL Finance carries an AA rating.

 

If you have a time frame of 70 months and above, opt for ECL Finance as it pays higher interest rates. If you have a shorter time horizon, go for Muthoot Finance. He feels these NCDs make better sense for investors whose income is not subject to tax, or are in the 10% or 20% tax bracket, and they can allocate 1015% of their debt portfolio to NCDs to earn higher returns. Investors to consider other factors like the rating, liquidity and post tax returns before finalising investment in NCDs.


Match Investment Horizon Financial advisors ask investors to choose NCDs based on their cash flow requirements. For example, they would recommend NCDs of Muthoot Finance to investors with shorter investment horizon, and ECL Finance to investors with a longer investment horizon. This is mainly because it is not easy to sell an NCD if there is an urgent need for money . Even though NCDs are listed in the stock exchanges, they are not traded frequently due to their smaller issue size. Invest in these NCDs only if you plan to remain invested till maturity, else could end up selling them in the secondary markets at a discount.


Consider the Ratings ECL Finance scores on the rating front, compared with Muthoot's AA rating. The NCDs of ECL Finance are unsecured, while Muthoot Finance offers a mix of secured and unsecured NCDs.


The 75-month NCDs of Muthoot are unsecured, while the rest of the NCDs are secured. Experts ask investors who value safety to opt for secured NCDs.

If a company goes bankrupt, secured NCD holders will be paid off first by selling the company's assets, and then whatever is left will be used to pay unsecured debtors. He prefers secured NCDs of Muthoot Finance and ECL Finance. Also, NBFCs carry higher risk. Muthoot Finance is primarily a single-prod uct company de uct company dependent on gold loans. Fluctuations in the price of gold could impact its earnings, while ECL's is primarily into businesses relating to the capital markets business. Any slowdown in the capital markets could affect its earnings. That is why many advisors caution against going overboard on these NCDs. If you have already have invested in the earlier issuances of Muthoot and ECL Finance and do not have a further appetite for unsecured and AA rated NCDs, you could avoid these issues.


Calculate Post-tax Returns Since interest income on NCDs is taxed, these instruments do not make much sense for investors in the higher tax bracket. So, if you are in the highest tax bracket, the post tax returns for an AA ECL Finance NCD would be 8.29%, which is unattractive when compared to other tax-free products like the PPF, which pays you 8.7% or tax free bonds from PSUs in the secondary market, which give you anywhere between 8.2-8.3%.

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