Bond Watch. Buying NCDs from secondary market

Investors with a medium-risk profile looking for options other than fixed deposits and debt MFs can consider investing in the taxable non-convertible debentures (NCDs).

Many high-rated NCDs with attractive yields and good liquidity are actively traded on the BSE and the NSE.

NCDs are fixed-income instruments issued by companies to raise long-term funds through a public issue. They are issued with a specified tenure — normally one to seven years.

The holders of the NCDs receive interests periodically or at the end of the tenure.

The yields on these instruments are linked to interest rates prevailing in the market. Given that the rates are bottoming out, NCDs yields are also relatively lower now — in the 8.5-12 per cent range.

The NCDs that were issued for retail investors by Dewan Housing Finance, Reliance Home Finance, IndiaInfoline Housing Finance, Shriram Transport Finance Company, Shriram City Union Finance, Srei Equipment Finance, Tata Capital Financial Services, SBI, Muthoot Finance, Manappuram Finance, Religare Finvest, SREI Infrastructure Finance and M&M Financial Services are traded actively in the secondary market now.

While investing in NCDs through the secondary market, investors should not just look at the coupon rate and market price of the bonds. There are three other parameters that the investor should also consider -- credit rating, YTM and liquidity.

Rating matters

Those who like to play it safe should focus more on credit rating — higher the rating, lower the default risk.

The NCDs issued by Dewan Housing Finance, SBI (lower tier-II bonds), Indiabulls Housing Finance, M&M Financial Services and NTPC are rated at the highest notch of ‘AAA’ by credit rating agencies.

The bonds issued by Shriram Transport Finance, Srei Equipment Finance, Edelweiss Capital and Reliance Home Finance hold ‘AA+’ status, while those brought out by IFCI and Manappuram Finance have ‘AA-’ rating.

One can get relatively higher yields in bonds with a lower rating as they are more prone to default risk.

Yield to maturity

When an issue opens in the primary market, the coupon rate on the bond is clearly stated, which is the annual rate of return on it.

But in the secondary market, the coupon rate does not matter. This is because the bond may trade below or above its issue price in the secondary market. So, what matters is the yield-to-maturity (YTM).

YTM is the internal rate of return earned by an investor who buys the bond today at the market price, assuming that the bond will be held until maturity, and all coupon and principal payments are made on schedule.

This can be done with the help of a financial calculator or excel sheet.

Data compiled by HDFC Securities shows that the NCDs with highest rating of ‘AAA’ offer yield in the 8.5-10 per cent range while bonds with ‘AA+’ and ‘AA-’ offer yields around 9-12 per cent.

Liquidity

Liquidity is also crucial — higher the liquidity, better is the price discovery.

HDFC Securities data shows that out of the 296 series of listed NCDs, only 20 bond series have been traded with daily average volume of at least 300 units in the last one month, either on the BSE or the NSE (as on April 3, 2018).

Taxation

The interest received from NCDs are taxed, based on the investor’s tax bracket.

Selling NCDs in the secondary market attracts capital gains tax.

If you sell within 12 months from the date of buying, you will have to pay tax on the gains as per your tax slab.

If you sell after 12 months, tax has to be paid at a flat 10 per cent rate. There is no indexation benefit available.

Our take

Though NCDs offer better yields than bank FDs, they are prone to credit and interest rate risks.

However, those who wish to invest in them should consider NCDs with higher rating, good yield and liquidity.

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