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Comparing NCDs/Bonds and Debt Mutual Funds

27 Feb 2021 0 COMMENT

If you are investing regularly, you are aware of different asset classes. You balance your portfolio by spreading your investment between equity and fixed income assets. Government and corporate bonds or debentures have been the most commonly used fixed income instruments. Regular investment in debt mutual funds can add more diversification to your financial platter. Know more about these investment products before you choose to put in your hard-earned money.

Basics of bonds

Bonds are debt instruments issued by governments or corporates for a fixed tenure. When you invest in a bond, you are bound to receive fixed returns every year from the issuer. At the end of that predetermined tenure, your bonds mature, and you get the principal back along with any outstanding interest return. The interest from bonds is not affected by market conditions, and hence it's one of the most preferred debt instruments.

There are four main types based on the issuing authority:

  • Corporate bonds
  • Municipal bonds
  • Government bonds
  • Agency bonds

Apart from these, there are different types of bonds, depending on their quality or variety:

  • Convertible bonds: These are issued by corporations and can be converted to shares of the issuing authority’s stock.
  • Non-convertible bonds: Unlike convertible bonds, these cannot be converted to stock.
  • Tax-free bonds: The interest received from these bonds is fully exempted from income tax.
  • Capital gains bonds: These are one of the best ways to save long-term capital tax.
  • Bank bonds: Banks issue these to fund their operations.

An unsecured bond can be called a debenture. There is only a slight difference between bonds and debentures: the latter are issued only by companies and not governments.

What is NCD?

One of the most common types of debentures is the non-convertible debenture (NCD). A subscribe can convert a convertible debenture into stock, while an NCD does not have that provision. When a company wants to raise money without diluting its equity structure, it goes for the NCD investment strategy. Here the investors get a fixed rate of income. Of course, a company with a brand value can quickly raise more money in the market as people trust it to repay the loan.

What are debt funds?

A mutual fund is an investment scheme that collects money from investors and then uses this accumulated corpus to buy/sell financial instruments. You can choose the investment category for your funds. If you decide to invest in debt, that mutual fund is known as the debt fund or debt mutual fund. These funds are all about investing in debt instruments. You can decide to sell the returns from debt mutual funds at the current market price. Another option is a reinvestment through the fund manager.

Comparing bonds/debentures and debt mutual funds

You can compare bonds/debentures and debt mutual funds on certain essential financial aspects. Following are some of these points:

Fixed income for investors: Bonds provide fixed returns to the investor as the promised interest rate isn’t affected by market fluctuations. However, debt funds do not come with any fixed income. Here the returns depend on the current market price of the underlying bonds.

Liquidity

Open-ended mutual funds are available for redemption whenever you need the money. That is not the case with bonds. They come with a fixed tenure, and you can redeem them on maturity. Some are listed in the debt market on stock exchanges.

Risk

Bonds always promise fixed pay-outs at fixed time intervals. They also return the principal amount on maturity at the end of the predetermined tenure.  But debt mutual funds do not promise any return. So, you have to invest in these mutual funds by calculating the risk-return reward.

Portfolio management

It is not easy to identify the right type of bonds independently. The ratings of bonds help you choose them. When creating a portfolio of bonds or NCDs, you need to know about them well. On the other hand, if you invest in a debt fund, you get a ready portfolio managed on your behalf by a qualified fund manager.

Accessibility

Mutual funds have emerged as popular investment options. You can buy them online or offline. You can invest in a mutual fund or access them from home comforts by merely clicking a button. But bonds are not always accessible online. It would help if you had a full-service brokerage to offer you online investing in bonds.

Summing up

As an investor, you must believe in your investment horizon and financial goals. Many investors, even the savvy ones, buy bonds to bring stability and market volatility exposure. Of course, you can also choose debt mutual funds to diversify your investment portfolio. Open your account with ICICI direct and take advantage of this diversification.