Factors you must consider before investing in companies' fixed deposits

Debt investments offer assured returns, but little else. One problem is lack of options. The other is that the returns, although guaranteed, rarely beat inflation. Not to mention that apart from Public Provident Fund, few debt instruments provide tax exemptions; returns from all others are added to the investor's income and taxed according to the tax slab.

But there is a debt investment that provides a fair degree of safety and still gives double-digit return, even after taxation. Company fixed deposits, or FDs, have for long been living in the shadow of the humble but ubiquitous bank FDs. However, in recent years, investors have started taking a good hard look at company FDs too. Does it make sense to invest in them? And, if yes, what factors should you consider before putting your hard earned money in these instruments?

HIGHER RETURNS

While bank FDs return 8-9% a year, company FDs offer one-two percentage points more. In fact, some pay as much as 12.5% per annum. Experts say this is a win-win for both the company and the investor. Every company, big or small, has to raise capital at some point, and FDsare a good way of doing that.

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"The other option is borrowing from banks, which is more expensive," says Anil Rego, CEO, Right Horizons. However, remember that compared to bank FDs, company FDs are riskier. The investor may lose his entire capital if the company defaults. In case of banks, deposits up to Rs 1 lakh are insured by the Deposit Insurance and Credit Guarantee Corp. So, before you put money in a company look at the quarterly and annual numbers and compare them with that of its rivals. Also, check the total debt and see if the company is in a position to service it comfortably without a big strain on its earnings.

RATINGS AND RETURNS
It is common for most company FDs to be rated. Crisil, which has been rating company deposits for over a long time now, gives FAAA as the highest rating, which denotes a high level of safety. "We arrive at the ratings after analysing the company's fundamentals over various parameters. Factors like industry outlook also play a small part, but the company's fundamentals remain the most important factor," says Rupali Shanker, director, CRISIL Ratings.

Experts say investors must avoid issues that are rated below AA. For example, the Kerala Transport Development Finance Corporation issue, which is paying 10.5% per annum, is not rated. In fact, experts say the interest rate is inversely proportional to the rating. "The stronger the rating, the less the chances of the issuer offering a high return," says Pankaaj Maalde, chief financial planner, apnapaisa.com. This explains why most top rated companies offer 10-11% per annum. "With good rating, companies are confident of getting subscribers," he says.

SHOULD YOU INVEST?

Company FDs have become popular over the past few years. As far as returns go, it is hard to argue against the desire to earn 10.5% against 9%, especially if the former is being offered by a reputed company with good ratings, which are a confirmation of its capability to repay the investor. However, check the fundamentals of the company and the sector before taking the plunge. Also, with online banking, a bank FD is available as per convenience, while an FD issue of a company that you are comfortable investing in may not be available all the time. Remember that FDs are tax-inefficient and, hence, their returns rarely beat inflation after taxation. This is because the interest earned is added to the income and taxed according to the person's tax slab.

Also, most company FDs have a long tenure. There is always a risk that the fortunes of companies may change for the worse during this period. Hence, longterm FDs will always remain risky irrespective of their ratings. For people looking to invest in a company while avoiding equity, NCDs (non-convertible debentures) are a good option. This is because most NCDs are secured.

Then there is the problem of liquidity. In bank FDs, you have the option of premature withdrawal by paying a penalty. But in company FDs, this can be a tricky affair. So, you have to be absolutely sure that you will not need the money in the coming days.