How can you make safe debt investments?

The IIFL NCD (non-convertible debenture) issue has opened already on 5 September 2012. I have written about it in an earlier article.

Shriram City Union Finance NCD opens on 12 September 2012. Religare Finvest NCD and Muthoot Finance NCD are expected to open for subscription soon. All of them are NCDs issued by NBFCs (non-banking financial companies).

In this article I will cover relevant principles for making safe debt investments. They apply to investing in the recent NCD issues as well as other debt instruments.

Benjamin Graham

Benjamin Graham

Benjamin Graham taught a very famous student at Columbia University business school . That student was Warren Buffett. Surely, most of us know who Warren Buffet is and his proven ability for generating long-term wealth with sound and profitable investments.

Benjamin Graham also wrote a very famous book called Security Analysis.

Principles you should follow for debt investments

1. Safety is measured not by specific lien or other contractual rights, but by the ability of the issuer to meet all of its obligations.

Lien in plain English means the right of the lender to possess the security that is offered by the borrower while taking a loan from lender.

What this principle says is that one should not rely only on the fact that a borrower is ready to make a promise, on paper, while obtaining a loan. More importantly, there should be concrete ability to fulfill all dues and pay timely interest and repay principal to clear the loan.

In his book, Benjamin Graham writes,

…the primary aim of the bond buyer must be to avoid trouble and not to protect himself in the event of trouble.


2. This ability should be measured under conditions of depression rather than prosperity.

This one is pretty self-explanatory. Please read the earlier article at Capital Orbit that talked of the large number of debenture issuing companies that defaulted over 1998-2002 in India.

If you read the old newspaper articles you will see that things can go wrong!

We know that right now there are not too many options in debt apart from fixed deposits. Consumer Price Inflation is higher than what we are earning in fixed deposits. We are facing, what economists call a negative real interest rate (when inflation is higher than the interest you earn in debt).

Needless to say, our wealth is being eaten away by inflation.

Yet, should we act out of desperation?

Benjamin Graham writes,

The fact that no good bonds are available is hardly an excuse for either issuing or accepting poor ones.

Try to see how the company that you are buying a bond or an NCD from will fare in the worst-case.

Are they strong enough to tackle an economic downturn?

Are they strong enough to face headwinds in their industry?

Will they be hit if regulations governing their industry are tightened?


3. Deficient safety cannot be compensated for by an abnormally high coupon rate.

A Corporation Bank fixed deposit for 5 years pays 9% today. The recent NCDs like IIFL CD and Shriram City Union Finance NCD, promise interest rates higher than 11.5%.

Most will say, let us take the extra 2.5%.

But, the right question is, is the debenture issuing company safe?

For the latest set of NCDs, you can say that you will refer to the credit ratings done by the credit agencies – CRISIL, ICRA or CARE.

Remember that credit rating agencies in the US are perceived by many to have been sleeping at the wheel in the years prior to the credit crisis of 2008.

Do read credit ratings. But never rely on credit ratings alone. Do your own study too.

And, yes, if you feel that it is a risky issue, forget the extra 2-3%. It really does not matter.

Do not be tempted by high interest rates on offer if there are too many risks or gaps in information that you cannot understand.


I leave you with a brilliant line that he wrote on investing in bonds (a debt instrument),

Since the chief emphasis must be placed on avoidance of loss, bond selection is primarily a negative art. It is a process of exclusion and rejection, rather than of search and acceptance.

Be a wise investor.

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  1. Rajini says

    Nice article.
    But still leaves me with question – which of these NCDs are worth investing?
    - IIFL (heard its oversubscribed), Shriram City Union Finance, Religare Finvest or Muthoot Finance

    • says

      Thanks Rajini.

      I shared my views on IIFL NCD in the earlier article. I will be covering the others one by one. Please come back to the site in a day or two. Alternatively, you can sign up for the mailing list and that way you will not miss any post at Capital Orbit.

  2. Anurag Satija says

    Can you pl clear the Air as one should invest with Muthoot or Finvest or which one for better interest rates or with a Bank normal FD’s

    • says

      Hi Anurag, I analyzed Religare Finvest, IIFL NCD etc. I didn’t find them interesting. I have not looked at Finvest. From a capital protection perspective, many retail investors are not placed to analyze NCDs. If you are not sure of what you are investing in, please don’t. If you indeed want to participate in debt, why not look for a decent debt mutual fund with a good track record? You rightly might be having a concern that bank FDs interest receipts are taxed as per your tax slab, not leaving a lot in your hand. Certainly, lesser than inflation.

      Debt mutual funds invest in a diversified portfolio of debt instruments. It might be a safer bet for a retail investor who is not aware of the risks in NCDs.

      If you still have doubts, do get back.

  3. Anil Kumar Tulsiram says

    I fully agree with you Kunal. Knowledge which we get after doing courses like CFA is rubbish. CFA taught me that to earn higher return we have to take higher risk, its only after learning from great investors like Seth Klarman, I understood that lesser the risk, higher the return. Two years back I had invested in Unitech FD looking for higher returns, but after reading security analysis (yes never read it till I started on my own a year back) decided to stick to debt mutual funds which invest in sovereign bonds. [short term or long term depending on interest rate cycle.

  4. says

    Anil, I would not say all of what is taught in CFA is rubbish. We can pick the useful stuff. I also believe that you do not need degrees/certifications to be a good investor.

    On the specific point about risk-return tradeoff I do agree with you completely. Its so obvious, yes!

    I have also benefited from reading Security Analysis. Debt MFs are a better bet, I agree. Especially if we are not sure of direct debt investments. Many debt mutual funds also have holdings in debt instruments that do not inspire a lot of confidence! To that extent, gilt mutual funds are better if you don’t want to take credit risk.

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