This story is from February 16, 2015

Company FDs, NCDs give you higher returns than bank FDs

While the prospect of further rate cuts by the RBI are boosting sentiments in the stock and bond markets, it is also making traditional fixed income investors nervous.
Company FDs, NCDs give you higher returns than bank FDs
While the prospect of further rate cuts by the RBI are boosting sentiments in the stock and bond markets, it is also making traditional fixed income investors nervous. Sooner or later banks and other institutions will bring down the rates on offer. But there are ways to continue enjoying higher returns for some time.
Lend to corporates
While bank fixed deposits and recurring deposits would be the obvious choice, those with a higher risk appetite and looking for a higher yield may opt for any of the corporate fixed deposits or debentures available.
Experts reckon investors can lock in to current high yields be fore rates on these instruments also go down.Vivek Rege, MD, VR Wealth Advisers, says, "In the midst of falling rates, you may not get such opportunities for a while." Investors can get anywhere between a 50-200 bps (0.5%-2%) higher yield on the range of company FDs, compared to bank FDs. Fixed deposits from non-banking finance companies (NBFCs) are offering 9.5% to 11% for three year tenure under the non-cumulative interest payout option (See chart). Certain manufacturing companies are offering higher coupon rates, in the region of 12% on three-year Fds. The interest earned on these company deposits is taxable at the rate applicable to your income tax slab.
You may also consider putting your money in non-convertible debentures. Although there are hardly any fresh issues, you can purchase any of the existing instruments. Invest only in those instruments which are not maturing within the next one or two years. Since rates are expected to fall in the coming year, opting for a NCD which will mature 12-18 months from now will expose you to reinvestment risk, where you will be forced to park the maturity proceeds at a lower rate. For instance, Shriram Transport Finance NY bonds offering a coupon rate of 11.25% under the cumulative payout option has a residual maturity of 1.52 years. The yield-tomaturity (YTM) on these bonds is 10.6%. On the other hand, the Shriram Transport Finance NU bonds with same coupon have a residual maturity of 2.55 years. They are current-ly offering a YTM of 10.72%.
A benefit of opting for NCDs is the possibility of capital appreciation. This offers you a chance to sell them at a profit, instead of holding on to them till maturity. Raghvendra Nath, MD, Ladderup Wealth Managment, says, "With bond yields likely to come off by 1-1.5% in the coming months, investors could fetch decent capital gains on their NCD holdings." Besides, NCDs are a tax-efficient option as these are eligible for long term capital gains after a year. This means your gains will be taxed at a lower rate of 10% instead of at the rate corresponding to your income tax slab. However, the interest earned on these NCDs will be taxable as per the tax slab of the investor. Keep in mind though that these NCDs are not easily tradeable despite being listed on the exchanges. The trading volumes in some cases are very low, which makes it difficult for the buyer or seller to enter or exit at the desired price point.

Credit quality is crucial
In both cases, investors must give due importance to the credit quality of the issuer. While your bank FDs offer the highest degree of safety, company FDs and NCDs carry a much higher degree of risk as these are unsecured instruments. Invest only if you are convinced that the issuing company's financials are strong. Rege cautions, "Do not get swayed by the higher yield. Ensure the company's business model and financials are strong." This can be gauged from the credit rating assigned to the paper by the rating agency . 'AAA' or similar rated papers offer highest degree of safety, but fetch lower return. 'AA' and lower rated papers come with attractive coupon rates, but imply a higher degree of risk.
Investors need to be careful when dealing with lesser known names. Nath says, "You may take a call on lower quality paper provided you are dealing with marquee names in the manufacturing space."
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