In bonds, the yields are known in advance. At the other extreme are equity investments, whose returns are uncertain. Market Linked Debentures (MLDs) combine the two. LDMs are bonds / debentures whose coupon or interest payment is not defined as in usual bonds. The “payout,” which is your return from the instrument, is contingent on movement into another market, called the underlying. The underlying can be an index or a stock or any other asset such as Nifty, Sensex, any basket of stocks, government securities or gold, to name a few. . The advantage is that you get the advantage of investing in another market by simply purchasing a debenture.

They provide principal protection (PP), i.e. regardless of the movement of the underlying market, you will get the principal back at maturity. So your downside in a PP structure is capped because the worst possible return is zero. The increase depends on the evolution of the underlying terms and MLD.

Two options

A point to note is that under some product structures the link to the underlying market is real. In some other products, the underlying market link conditionality is designed with low probability, so that you have a high degree of certainty about returns. These are called fixed income structures and are more popular. Here, although there is a link to an underlying, the conditionality is maintained in such a way that the probability of obtaining the indicated return (XIRR) is almost certain. In real market oriented structures, the gain depends on the movement of the underlying.

More than 80% of the issues in the market are focused on fixed income securities. By way of illustration, a fixed income oriented MLD may have a condition that if the Nifty as an underlying does not fall 75% from the initial level or if the price of a government bond at 10 years does not fall by 75% the investor will obtain the indicated return. As this condition is highly unlikely, the investor can visualize the return. In a true market-oriented structure, the terms would say something like this – if the Nifty goes up by X percent, the investor would get 75 percent of the upside.

Tax efficiency

LDMs are tax-efficient. There is no coupon payout, as they are by definition dependent on the underlying market movement. The main protected structures are listed on the stock exchange and, therefore, over a holding period of more than one year, become eligible for the taxation of long-term capital gains (10 percent plus surcharge and cess.

Compared to ordinary bonds, tax efficiency is significant. The usual bond coupons and zero coupon bonds are taxed at the marginal tranche rate, which is 30 percent plus surcharge and tax. The term of MLDs should be at least one year from a tax efficiency perspective, which is the required LTCG horizon for listed bonds. Usually, the term of office varies from 15 months to just over three years. These are HNI products and are not intended for retail investors. Although there is no legally defined minimum ticket size (like ₹ 50 lakh in PMS), wealth management companies would like to sell tickets of, say, ₹ 1 crore. But the size of the ticket may vary. It also depends on the face value. If the face value is 10 lakh, it goes in multiples of 10 lakh.

The risk factors in LDMs are twofold: (a) default risk, which can be measured from the credit rating and (b) liquidity, there is no liquidity in the secondary market. Therefore, if you need to redeem before maturity, there may be no buyer. Nowadays, many transmitters are entering the market. The presence of an AAA rated PSU transmitter in this space, such as the Rural Electrification Corporation, implies that the concept of MLD enjoys the implicit support of the government.

New private sector issuers entering this segment include Shriram Transport Finance, Muthoot Fincorp, Shriram City Union, Hinduja Leyland Finance, Manappuram Finance and M&M Financial Services. This product is largely intended for HNIs and is not yet available in retail lots. Issues are made through private placements (as opposed to public issues). Investors can take advantage of this product from wealth managers and a few select bond houses.

The author is a trainer and business author



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