What is a Non-Convertible Debenture? Features, Risks and Rewards Explained

Non-Convertible Debentures (NCDs) are an attractive fixed-income instrument that allows companies to raise funds while offering investors the opportunity to earn stable and predictable returns. Unlike convertible debentures, NCDs cannot be converted into equity shares of the issuing company, which makes them a preferred choice for investors looking for secure, interest-based income rather than potential capital gains through shareholding. This article explains what a non-convertible debenture is, how it works, its benefits, risks, and important factors to consider before investing.

What Is a Non-Convertible Debenture (NCD)? 

A Non-Convertible Debenture is a debt instrument that is issued by a company to borrow money from investors for a specific time frame. It comes with a fixed interest rate and a pre-defined maturity date. Unlike a convertible debenture, an NCD does not offer the option to convert into equity shares, making them purely a debt product.

Companies issue NCDs to meet capital requirements, fund expansions, or manage operational costs. NCDs are listed on stock exchanges, which allows investors to trade them in the secondary market. The fixed interest rate provides a predictable income stream, making them appealing to conservative investors. 

Key Features of NCDs 

1. Fixed Income: NCDs offer investors a predetermined interest rate, ensuring regular income over the investment tenure.
2. Tenure Options: The maturity period for NCDs usually ranges from 1 to 10 years, providing flexibility to investors based on their financial goals.
3. Secured or Unsecured: NCDs can either be secured, backed by the issuing company's assets, or unsecured, which carry slightly higher risk.
4. Liquidity: Listed NCDs are tradeable on stock exchanges, offering investors the ability to sell them before maturity if needed.
5. Credit Rating: NCDs are rated by credit rating agencies. A high rating (e.g., AAA) signifies lower credit risk, while a low rating indicates higher risk.
6. Interest Payout Options: Investors can choose between various payout frequencies, such as monthly, quarterly, semi-annually, or annually, depending on the issuance terms.

How NCDs Work 

When companies need to raise funds, they issue NCDs as a means of borrowing from investors. Investors purchase these instruments by lending money to the issuing company, which promises to pay regular interest and return the principal amount at the end of the tenure.

For example:

• A company issues NCDs at a face value of ₹1,000 each with a 9% annual interest rate and a 5-year tenure.
• If you invest ₹1,00,000 in these NCDs, you will receive ₹9,000 as interest each year for five years, and the ₹1,00,000 principal amount will be repaid at maturity.

NCDs are listed on stock exchanges, so you can trade them before maturity. However, their market value may fluctuate based on interest rates and creditworthiness of the issuer.

Benefits of Investing in NCDs 

1. Predictable Returns: The fixed interest rates provide consistent income, making NCDs an excellent choice for conservative investors.
2. Higher Interest Rates: NCDs often offer higher returns compared to traditional savings instruments like fixed deposits.
3. Diversification: Adding NCDs to your portfolio diversifies your investment across asset classes, reducing overall risk.
4. Liquidity: Listed NCDs can be sold in the secondary market, providing flexibility if you need funds before maturity.
5. Customisation: NCDs come with various options for tenure and payout frequency, allowing investors to align their investments with financial goals.

Risks Associated with NCDs

Although non-convertible debentures offer a variety of benefits, like any other financial product, they come with some risks that you should be aware of before investing.

1. Credit Risk: There is always a risk that the issuer might default on interest payments or principal repayment.
2. Interest Rate Risk: If market interest rates rise, the market value of your NCDs may decline, impacting your returns if sold before maturity.
3. Liquidity Risk: Some NCDs may have low trading volumes on stock exchanges, making it difficult to sell them.
4. Taxation: Interest earned on NCDs is taxable under the investor’s applicable income tax slab, reducing post-tax returns.

NCDs vs Convertible Debentures: Key Differences 

While both, non-convertible debentures (NCDs) and Convertible Debentures, are types of bonds issued by companies to raise capital, they come with distinct features that make them suitable for different investment goals. Understanding the key differences between these instruments can help you make informed decisions based on your preferences and financial objectives.

How to Invest in NCDs

1. Primary Market: Companies offer NCDs through public issues. Investors can apply during the issuance window via brokers or online trading platforms.
2. Secondary Market: Listed NCDs can be purchased or sold on stock exchanges, such as NSE or BSE.
3. Evaluate Ratings: Always check the credit rating of the NCD before investing. Higher-rated NCDs usually indicate lower risk.
4. Check Tenure: Choose NCDs with a maturity period that matches your financial goals.
5. Tax Implications: Understand the taxation on interest earned and its impact on your overall returns.

Factors to Consider Before Investing in NCDs 

• Issuer’s Creditworthiness: Assess the financial health and reputation of the company based on its credit rating to ensure repayment capability.
• Interest Rate: Compare rates across NCDs to find the optimal returns while considering the associated risks.
• Liquidity: Ensure that the NCD is listed on exchanges with adequate trading volumes for easy buying or selling.
• Secured vs Unsecured: Choose secured NCDs if you prefer lower risk, as they are backed by the issuer’s assets.
• Diversification: Avoid over-investing in a single NCD issue; spread your investments across issuers in terms of duration of the instrument, and credit rating of the issuer to reduce risk.

Conclusion

Non-convertible debentures (NCDs) are a popular investment option for individuals seeking fixed returns and portfolio diversification. While they offer attractive interest rates and liquidity, investors must carefully evaluate the risks and choose NCDs that align with their financial goals.