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Monday, June 2, 2014

NCDs - Attractive Returns

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State Bank of India, the country's largest, offers 8.75 per cent interest on its one to five- year fixed deposits. No wonder there is a lot of interest when non- banking financial companies Muthoot Finance, India Infoline Finance and Shriram Transport Finance Company are offering 11- 13 per cent on non- convertible debentures (NCDs).

But who should invest in these? As far as fixed income instruments go, directly- comparable instruments are bank, company fixed deposits and tax- free bonds trading in the secondary market. Then, there are fixed maturity plans where the rate of return is more or less known.

For investors in the 10 and 20 per cent income- tax bracket, these bonds make more sense because the returns will be slightly higher.

But investors in the 30 per cent bracket have other options. NCDs' capital gains will be added to your income and tax, in line with the slab. So, if an NCD is being offered at 13 per cent, the post- tax rate of return would be 9.1 per cent for the investor in the 30 per cent income- tax bracket ( without including education cess). For the investor in the 10 and 20 per cent bracket, it would be 11.7 per cent and 10.4 per cent, respectively. So, the returns in the lower tax bracket are substantially better when compared to fixed deposits.

The investor in the 30 per cent bracket has more options. Tax- free bonds (AAA rated) are trading in the secondary market at 8.5 per cent. For 50- 60 basis points, investors would be getting AAA rated papers instead of AA rated papers in case of NCDs. So, it would better if they invest in tax- free bonds. Another option for those in the highest income- tax bracket is fixed maturity plans. These are offering 8.75- nine per cent. And, of course, there would double inflation indexation benefits on these unlike NCDs.

But before you jump to buy these instruments, financial planners say there are three key things you should look for: Return after taxation, credit rating and tenure.

Credit rating is an important aspect of any debt instrument.

Higher the rating, lower the rate of return. If companies are offering very high rates, the rating may be lower.

Avoid such issues because of the uncertainty.

Then, consider the tenure carefully. Companies issue NCDs with various options. Muthoot Finance is giving 11 options with tenures ranging from 24 months ( two years) to 75 months ( six years and three months). The rates of interest also differ from 11 per cent to 11.75 per cent. If the tenure matches your requirement, it makes sense to go for these. There is good reason to match the tenure because if you need to sell it to raise cash, the secondary market is not so robust. According to market experts, it could even take a week or more to sell these instruments through the exchange route

For further information contact Prajna Capital on 94 8300 8300 by leaving a missed call

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