In very simple terms, Non Convertible Debentures (NCDs) are a loan to the company issuing it. This loan, or NCDs, cannot be converted into equity. Public or Private companies issue NCDs to fund many activities such as growth plans, corporate expenses, pay out earlier loans, working capital, etc. I consider NCDs as a form of  private or public sector bonds, depends upon who issues it.

The key attractive aspect about NCD is they are fixed income vehicle with capital being secured. In general, NCDs offer returns that are 2% to 4% higher than savings, CDs, or some of other government bonds. For example, the current L&T offers interest rates in the range of 9.51% to 10.24%, while Shiram Transports offered NCD upto 11.5%.

NCDs are typically offered when companies believe that public offering of common shares are not good options. In current environment, corporates will not be able to price their common or preferential shares at higher valuations. At lower valuations they not only get less capital, they also have to forego a higher dilution. In addition, for retail investors, the low volatility, security, and higher interests allows corporate to raise the required level of funding.

So far in 2009 alone markets have already had few large NCD issued by Tata Capital, Shiram Transport, and Tata Motors. The latest NCD open to retail investors is from L&T where the company is attempting to collect Rs. 500 crore (with additional Rs. 500 crores as an option). Furthermore, HDFC has NCD open for qualified institutions where this company is attempting to raise Rs. 4000 crore.

The concern I have with NCDs and Indian corporates issuing them is the lack of transparency. Every NCD basically covers the whole gamut of reason for issuing NCD. To provide more wriggle room, Indian corporates include all possible reasons under the sun such as growth, working capital, lending, expenses, repaying old debts, etc. I do not like this. In short, they say, give us money and we will give you interest. Rest leave it to them. I do not like this aspect. Unfortunately we are in an environment where individuals have no choice. Period.

In reality, NCDs are not fully secure. They are just as risky as stock in markets. NCDs are exposed to corporate risks. The corporate risk comes from companies making sustained losses, survivability of the company, frauds, etc. For example, had Satyam been exposed to NCDs, individuals would have had hard time recouping their principal money. Another example is Enron!

What should we as individuals do?
I do prefer to invest in NCD (i.e. bonds) and believe every individual should have some exposure to it. However, every individual should have proper asset allocation based on his/her risk profile. Just because it is offering higher interest rate and seems secure, does not necessarily mean, there has to be rush for it.

• If an individual already has allocated quite a bit of capital to fixed income (i.e. cumulative total to savings, CDs, government certificates, bonds, NCDs, etc), then taking on additional L&T or Shiram’s NCD may not be a good option. If you are under exposed, then yes these latest issues are good options.
• Always go time duration of 3 to 5 years for fixed income vehicles. It  helps to reduce risk from different perspective;
• Folks in 25 to 30 years of range will do good to limit their fixed income exposure to less than 10% to total assets;
• Folks in 30 to 35 years should go up to 25%; and
  
• Folks beyond 40 years should go up to 40% of their assets.

Each individual has to look at this in the context of you own risk profile and requirements. For some it may be good and for some it may not be a good option.