The returns on bonds are known upfront. On the other end of the spectrum are equity investments whose returns are uncertain. Market-linked debentures (MLD) combine the attributes of these two types of investments.
What are Market Linked Debentures and how do they work in India?
Market-Linked Debentures are instruments that do not have a fixed pay-off. Instead, their payoff depends upon the performance of another index like Nifty 50 or security like the 10-year G-sec. Upon maturity, a payoff or return payable is accrued along with the initial principal payment. This return payable is dependent on the movement of the underlying index or security that the Market-Linked Debentures follows, as initially defined in the terms. For instance, if the terms of investment state that 80 percent of the upward movement of the index is payable, then a 20 percent rise in the index would reap a payoff of 16 percent over the tenure of the MLD.
Moreover, a category of Market Linked Debentures called the principal protected MLD guarantees a payback of the principal amount even if the underlying index witnesses a negative performance. For instance, suppose a 9 percent coupon payment is attached to a Market-Linked Debentures with a G-sec maturing in 2030 as the underlying security. However, this payoff comes with a condition that the coupon payment will be made only if the G-sec does not fall 25 percent in price at the end of the Market-Linked Debentures tenure. If the G-sec price falls more than 25 percent, the investor only gets back the principal amount.
Hence, MarketLinked Debenture ensures that the investor is protected against a downside in the underlying market while extending lucrative gains if the underlying market witnesses a positive performance.
Nifty-linked debentures are debentures linked to a Nifty index like Nifty 50 or Nifty 100. The payoff from such debentures depends on the performance of the underlying Nifty index. So, if the index goes up, the investor makes commensurate gains and if it goes down, the investor still gets his invested money back.
4 Advantages of Market Linked Debentures
An MLD is a tax-efficient instrument, taxable at 10 percent plus surcharge and cess after a holding period of more than a year if in case investments are done in Nifty linked.
2. A wide array of choice
The biggest advantage of investing in Market Linked Debentures is that an investor can benefit from the upside of other markets like equity or G-secs without directly investing in these markets.
Moreover, many reputed business houses with top-notch credit ratings have entered the segment today. Thus, a wide array of choices in debentures with a good credit profile and a variety of underlying markets are available to an investor.
3. Protected against downside risks
Principal protected MLDs ensure that an investor is protected against the downside of the underlying market. Hence, as compared to a direct equity investment, where the investment is lost in the event of a downside, Market Linked Debenture protects an investor’s principal invested.
4. Superior returns
Market Linked Debenture offers commensurate gains to an investor as compared to traditional investments like fixed deposits as it lets the investor benefit from a market’s upwards performance.
Risks of Market Linked Debentures
1. Credit risk
The ability of the issuer of the debenture to meet its obligation and repay is of grave importance. There is credit risk involved as the issuer runs the risk of defaulting on the high returns that it promises its investors. An investor in such a case would suffer a capital loss if the issuer fails to fulfill its obligation.
2. Market risks
Though a principal-protected MLD protects against capital loss, a coupon payment based on certain market-linked conditions can cause a loss of gains. Hence, investors might need to base their investment decision based on the probability of the fulfillment of the predetermined market condition.
3. Liquidity risk
The payoff is acquired only at the end of the tenure. Hence, exiting mid-way and liquidating your investment is not an option.
4. Complexity risks
Some MLDs have complex structures and high investment thresholds which make them better suited for HNI who understand the nuances and have the funds.
Who and how can one buy Market Linked Debentures?
Anyone can invest in Market Linked Debentures. However, since they usually have a high face value, they are better suited for this. They can be bought from distributors or investment banks who offer these products on a commission. They are usually issued with a face value of Rs 10 lakh via an offline process. You can invest in Market Linked Debentures through BondsIndia by clicking on this link.
In the low-interest rate climate, market-linked debentures are attractive investments that protect against downside risks while ensuring attractive gains. Moreover, the benefits from tapping into different markets without direct investments and tax efficiency, make them worthy of a place in your portfolio, especially for this. However, like any other investment, MLDs are not devoid of risks and must be weighed against other investment options.