Debt tools look hot, but come with risks

The race for non-convertible debentures (NCDs) is going down to the wire, with non-banking finance companies furiously trying to outsmart each other in their attempt to catch more eyeballs. The latest to join the brigade is Muthoot Finance, which on Monday announced that it will open a public issue of secured, redeemable, NCD aggregating up to a total of Rs600 crore.  

Such debt products may have been the flavour of the season. But financial planners are far from amused, who say undue haste here may land one in trouble and ask investors to tread with care. In fact, they warn investors against jumping at the first opportunity.

Clearly, returns of debt instruments work to their advantage. At 10-14% these days, these often push investors to scale up the debt part in their investment portfolio. The Muthoot offering is a case in point. The issue, which opens on Thursday and closes on January 7, will offer an effective yield of 13.43% with four investment options. Investors who stay invested till two years will be offered yields of 13%, while those staying for three and five years will get rates of 13.25%. Over and above that, they have the option of locking in their funds up to five and a half years, where they can double their investments. The issue has a rating of AA- by Crisil as well as ICRA rating agencies.

“I wouldn’t recommend such a risky investment option to my clients. The AA- is not a very comfortable rating for a paper that offers such high interest rates. Even if the post-tax returns look attractive, I would rather suggest clients to put money in fixed deposits which may offer lower interests, but secured ones,” said Suresh Sadgopan, who runs Ladder 7 Financial Advisory Services. 

Though debt instruments sound extremely attractive with the kind of returns on plate, analysts are clear that it’s the time horizon that is the clincher, which  makes an equity investment look a better bet.

“Moreover, with the valuations being attractive, it needs to be capitalised and investments in equities should be increased, keeping longer term in mind,” said Mukund Seshadri, founder-partner, MS Ventures Financial Planners.

A standard, balanced investment portfolio will feature 60% equities while the other 40% would be in the form of debt. Financial planners suggest that if an investor is too focussed on debt, he would end up missing out on benefits that an equity investment can offer. What’s more, the interest earned by NCDs is taxable.

“If the money is needed in a short term, I suggest investing in a fixed deposit. At any point of time, they are more liquid in nature. In rising interest rate scenarios, the risk of reinvestment is less and it can always be redeemed and reinvested,” Seshadri said.

For customers who have a better risk appetite but are still wary of going in for equity, one would do well to look at the cost of finance and risk the company is taking. “The point is whether the company can service its promises in future also,” Sadgopan added.

But there is another school of thought. “For someone with a good risk appetite, who wants to invest in debt, I believe this is a good investment option as one can stay invested and treat it as a deposit till it matures,” says Harshvardhan Roongta, CEO of apnapaisa.com.