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Investment In NCD May Manifest A Good And Safe Deal Than Equities!
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Indian stocks have rallied more than 25% in the year 2021 on the back of more economy friendly policies, rapid vaccinations across India, positive outlook, capacity expansion, PLI scheme across crucial sectors and the reopening of almost all activities. As the market is booming and start-ups are making inroads on Indian bourses with high valuations, there are words of caution from market gurus on current market valuation! Recently Goldman Sachs said in their research note, "We believe the risk-reward for Indian equities is less favourable at current levels". The surge in valuations has also led several other brokerages such as Morgan Stanley, Nomura and UBS to slash their ratings on the market.
With blistering valuation and unfavourable risk-reward return, investors may overlook some other attractive opportunities across other investment avenues. India's debt market is turning eye-catching with non-convertible debentures (NCDs) offering returns in the range of 8-10% per annum.
Non-convertible debentures are securities that are defensive in nature which provides capital protection, steady income, liquidity and diversification to other asset classes such as equities.
NCDs act as a defensive portfolio stabiliser, akin to portfolio insurance, paying off during the periods when equities are stressed due to micro or global factors. NCDs are referred to as 'conservative' or 'defensive' assets because they usually deliver more stable returns with lower volatility than equities. This ensures that a steady income will be paid over the life cycle of the NCDs, and more importantly, the principal will be paid back at maturity.
It is imperative to understand this concept before venturing into the debt market:
What are Non-Convertible Debentures (NCDs)?
Non-convertible debentures (NCDs) are debt instruments issued by corporates for a specific tenure to raise capital for business expansion and to fund its growth etc. They cannot be converted into equity or stocks. The NCD performance is not tied to a company's performance or share price - it is a promise from the company to pay back interest and principal. NCDs have a fixed redemption date. The interest payment is made along with the principal component either monthly, quarterly, or annual basis, depending on the tenure. This makes NCD a better investment when looking for a more secure option to directly invest in these companies.
NCDs promise to Investor- Protect wealth and generate a reliable cash flow:
When investing hard-earned money, investors expect first capital protection and then return on investment, but equities can experience a capital wipe-out in just days. That's why more and more investors are turning to fixed income source like NCDs.
When a company launches the debt issue (NCDs), it is mandatory for a company to get a rating by at least one credit rating agency. The safety of money invested in NCDs is subject to the ratings and the nature of the debentures, i.e. secured or unsecured debenture.
Here's a quick look at some of the top pointers differentiating the NCD's from equities:
- 1. Term: NCDs have a fixed tenure, whereas equities are viewed as a perpetual investment.
- 2. Income: NCDs generates fixed income periodically over the term of the investment. On the other hand, there is no promise of dividends for equity holders.
- 3. Return: Fixed rate of return depending on the face value of the NCDs. There is no fixed return for equity holders, and future value is also much more uncertain and subject to volatility.
- 4. Capital: NCD's investors received full capital repayment at the end of their investment. Equity investors receive the market value of their shares at the time of sale.
- 5. Ranking: In the event of default, claims made by debt investors rank ahead of equities.
Safe Harbour -
To conclude, it is always a good strategy to manage both liquidity and risk. From that point of view, a non-convertible debenture is an ideal alternative to equities, provided they are issued by reputed companies and have a higher credit rating. We have highlighted the benefits of holding NCD's as part of a balanced portfolio that are timeless.
By including a fixed income allocation in a balanced portfolio, these features provide portfolio efficiency gains from reducing the variability of returns below the levels of the weighted average of the combined asset classes.
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