What are Market Linked Debentures: Benefits & Risks

What are Market Linked Debentures (MLD’s)

MLD, or Market-Linked Debenture, is a debt instrument like a “bond” that gives income linked to a specific market index (like Nifty). MLD offers two types of investment–

1. Principal protected: If the market index goes south, then the principal amount of the investor is returned.
2. Non-principal protected: There is no insurance against market downside. Hence there can be principal erosion to the extent the market goes down.

MLDs are issued for the period between 13 to 60 months and usually require a minimum investment of Rs 10 lakhs or more. The specialty of MLDs is that, unlike a bond that pays a fixed interest regularly, MLDs do not pay any regular income, instead only when they reach maturity date.

The Mechanism of Market Linked Debentures

An MLD is linked to underlying financial security for eg: a “stock market index” such as Nifty. Since there is no income to be had during its tenure, the gain achieved from an MLD is determined during maturity, based on how much the underlying asset has changed.

For example, if an investor has purchased an MLD linked to movement in Nifty with a promise to pay 70% movement in Nifty, then at the time of maturity, if Nifty has moved 40% (point to point), then the investor takes home his principal plus 28% (70% of 40%) return. There are MLDs which pay you 150% of the market movement also. So if Nifty has moved 40% (point to point), then the investor takes home his principal plus 60% (150% of 40%). 

Each issuer/firm can choose the underlying index or security with which the movement of MLD payoff for the investor is linked. It could be NIFTY, BANK NIFTY, Gold, or 10-year Government Bond yield. The crux is to select a widely traded security and not easily subjected to manipulation. The funds raised through MLD is engaged partially in business operations and partially in buying derivative instruments in order to pay back the investors.

Although principal-protected MLDs are listed & appear on stock exchanges, they are seldom traded, and the prospective investor should be ready to hold on to their investments till maturity. 

Benefits of Market Linked Debentures (MLD’s)

1. Tax Benefit: MLDs are taxed only at 10% under the condition that they are sold in the market after one year (unlike three years in debt-based mutual funds)     

For example: if one can get a 10% market-linked debenture, then it’s actually 9% if sold after a year. At the same time, a fixed deposit at 8% is actually 5.6% post-tax considering a 30% tax bracket.

2. In an oversaturated market, one can avail of the benefits of the upside of the market but be immune to the downside. 

3. MLDs are useful in the case of family offices or HNIs, both of whom are in the highest tax bracket and need a good post-tax return.

The Risks of Market Linked Debentures (MLD’s)

1. Since by purchasing MLD, one is effectively lending to a company so investors need to assess the credit risk. Some issuers provide multiple guarantees to investors. 
2. MLDs can’t be exited in the “middle” – the guarantees only apply if one stays till the end. So there’s liquidity risk involved.
3. There is also the risk of changing tax laws that changes the tax structure & regulations on exits of MLDs.
4. MLDs may appear to be juicy; these products are complex. It is not a simple & plain vanilla bond that is offered because the payoff may vary depending on the movement of underlying securities to which MLD is linked. Hence investor should consult an advisor before investing in such products.

MLDs are not just an ordinary assured return investment and are best avoided by novice investors or even those who understand markets well but don’t still get the complexities. Consider MLDs only if you fully understand them.

One good example of MLD is the ECAP GEM series offered by Edelweiss. Similar to the characteristics listed above, this offering by Edelweiss has the following features.

1. A listed rated market-linked debenture 
2. Opportunity to lock in Pre-Tax High Yield up to 9.50% p.a.
3. Principal Protected at Maturity & secured by 1x cover on Principal & Coupon against specific assets. 
4. Tax-efficient compared to traditional investment avenues. [It is taxed at only 10% post 12 month holding from the investment date]
5. Listed on BSE WDM 

So the ECAP GEM is the wholly-owned subsidiary of Edelweiss that provides MLD to the investor. The minimum investment amount is Rs. 10 lakhs for 42 months. Edelweiss has appointed a special “Independent Debentures Trustee” to safeguard the investors’ interests.

We hope this articles helps you understand What are Market Linked Debentures (MLD’s), its Mechanism, Benefits & Risks . If you need any assistance on Investments, Insurance or How To Invest In Mutual Funds Feel free to contact Wealth Baba. We will try to help you out in the best possible way.