Market Linked Debentures are debentures where the pay-off is not defined as in a regular coupon-bearing debenture, but linked to the movement in another security or index such as NSE Nifty index or 10-year government security (G-sec) yield. For example, a 30-month MLD would pay the investor a pre-defined IRR at the end of the tenure if Nifty 50 Index does not fall by more than 75%. Market-Linked Investments may provide full or partial market downside protection and/or enhanced return potential.
Why Market Linked Debentures (MLD)?
A market-linked debenture does not pay any coupon before maturity. On maturity, apart from the initial principal component, there is a pay-off, i.e., a return payable. The advantage is that you are getting the exposure and upside in other markets such as equity (NSE Nifty) or G-sec, without taking as much of a risk as in investing directly into that asset.
If you invest directly in the Nifty or gold and Nifty or gold value declines over the investment horizon, you would lose a part of the principal.
Benefits of Market Linked Debentures
Market-linked debentures can be designed in various forms and can be structured to provide different objectives under different conditions.
Taxation of this instrument is efficient. These are listed on the exchanges and capital gains from the listed debenture, after a holding period of more than one year, are taxable at 10 per cent and unlisted debentures are taxed at 20% post 3 years
The benefit that investors have in a structure like this is:
•Principal protection as compared to a pure equity investment where there is risk of capital loss
•Superior return potential vs traditional fixed income on fulfilment of an underlying equity condition
•Structure which is at a candy spot versus two traditional asset classes.
While the above example would be that of a simple structure, there are various other complicated structures like:
•Principal protected with a participation rate linked to an underlying index,
•Principal protected structures which gives a pay off if equity markets go down, •Less than 100% principal protection structures
Risks associated with Market Linked Debentures
•Although a majority of structures are principal protected, the ability of the issuer to repay is of huge importance.
•Investors may suffer a capital loss in case the issuer fails to repay on the obligation.
•Thorough due diligence on the issuer’s underlying business, its diversification and key financial ratios should be undertaken before investing.
•Fulfilment of the underlying market linked condition
•Secondly, payment of coupon depends upon a certain market linked condition.
•Investors need to determine a probability on the fulfilment of the underlying market condition.
•Due to the complexity of structures and higher minimum allocation, these structures are suitable for HNI and UNHI clients who understand the nuances correctly
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