Three debt bets for these risk-on times

When the deposit rates were high, fixed deposits (FDs) were among the best investment options available for debt investors. That seems to be changing with banks beginning to lower interest rates. The focus, thus, is shifting to other options. What are these?

Non-convertible debentures
There has been a slew of non-convertible debenture (NCD) issues recently. These debentures are luring customers with the high rate of interest being offered. Typically, NCDs offer up to 2-3% more than fixed deposits. When it comes to rate of interest they clearly score better. But before you leap, you must also take a look at the NCD’s ratings. These are bonds issued by a company so the rating depends on the company’s financials. A good rating signifies sound financials and ability to repay. Ratings are revised every few months.

Also, NCDs are non-convertible, meaning they can’t be converted into equity. The debentures can be of two types—secured or unsecured. The secured ones are backed by assets and offer a lower rate of interest compared to the latter.

Another thing to remember is liquidity. Is the issue good enough for there to be buyers when you urgently want to sell it for some cash?

In this scenario, the price that NCDs may fetch will differ according to the interest rate levels, the rating a company enjoys and the coupon amount.

The money earned from this is added to your income and then taxed according to the tax slab you fit into. Therefore, this is most suitable for people who are in the lower tax bracket.

Financial planners suggest that while NCDs are a good investment option, it’s not a great idea to be swayed by the interest rate on offer and assign your entire debt portfolio to these instruments.

“People who are in the lower tax bracket can look at making NCDs of highly rated companies a part of their portfolio,” said Jayant Vidhwans, director at Chaitanya Financial Consultancy. He said it is advisable at this time to go for a longer tenure paper. If you head for a shorter tenure, the interest rate may correct and then you will be faced with a risk of reinvesting the money possibly at a lower rate of interest.

Corporate deposits
Even with corporate deposits, you will need to scrutinise the deposit-taking company’s financials and the promoter’s details. Unlike a fixed deposit in a public sector bank, which is insured up to Rs1 lakh, corporate deposits are not secured.

So go for a company that’s listed and has issued CDs in the past. Take a closer look at the bad debt the company has — the lower it is, the better. Check its credit rating too.

“One should not go for corporate deposits that have a rating lower than AA+,” said Jayant Pai head — marketing, PPFAS Asset Management. Companies generally pay 1-3% more than bank fixed deposits. The catch is that a higher interest rate translates into higher risk.

Also, if you need to urgently encash, that’ll be difficult with a company deposit and there can be a penalty of up to 2%.

Pai said one should not look at locking in more than 15% of debt portfolio in company deposits.

Tax-free bonds
If you are a risk-averse investor, bonds issued by public sector undertakings are a good investment avenue since these are government-backed entities.

“These bonds can be bought either at the time of launch or later from the secondary market where they are traded,” said Suresh Sadagopan, who runs Ladder 7 Financial Advisory services. He cautions that these bonds are for a time period of 10-15 years, so it is best suited for investors with that kind of horizon. The interest rates on these bonds generally varies from 7.8% to 8.5%.

However, you need to understand that the interest rate being offered on these bonds can change. Therefore, you may need to monitor the interest rate cycle movement to time your entry and exit.

For people who are in the higher tax bracket, this clearly is the better option compared with NCDs. That’s because the returns are tax-free and so the effective yield increases.

Apart from these three options, financial planners continue to recommend Public Provident Fund and fixed maturity plans.