Investing

The case for investing in market-linked debentures that are fast evolving

The terms of the MLD define at the outset the extent of returns, depending on the price movement in the underlying market. Photo: iStock

Market-linked-debentures (MLDs) have been around for some time and have been accepted in the “wealth” market. They merit another discussion at this juncture due to two reasons (a) post Union budget, taxation of dividends from equity shares is a little adverse and preference shares have been impacted significantly from the taxation perspective, which may prod you to look at other products and (b) the profiles of issuers of MLDs have changed for the better. But let’s first recap what the product is.

These 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. 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. In MLDs, there is a category called principal protected (PP) MLD, where it is guaranteed that you will at least get back the principal amount on maturity, even if the movement in the other market is severely adverse. That is your downside is protected because in the worst case, you will get zero return but will get your investment amount back. On the other hand, if the movement in the other market is favourable, you will get commensurate returns. The terms of the MLD define at the outset the extent of returns, depending on the price movement in the underlying market.

There are two jargons in this product category: fixed and variable coupons. To be sure, in an MLD, the pay-off is not fixed per se but linked to a reference underlying security or index. Under fixed coupon, the range of the reference security or index is fixed so wide that it is almost certain that you get the return indicated. Under variable coupon, there is a real or palpable linkage to the reference market. This is more for participation in the equity market, where you can participate in the upside of the equity market, to the extent defined in the terms of the MLD, but with downside protection of PP structures.

The taxation of listed debentures is efficient. The capital gains from listed debentures, after a holding period of more than one year, are taxable at 10% plus surcharge and cess. There are non-listed MLDs also, but those are not tax-efficient. The MLD is sold off in a secondary market deal just before maturity. This means that there is no coupon flow in between your investment date and sell-off in the secondary market, and your return is capital gains from investment price to the sale price in the secondary market deal. There being an element of uncertainty in returns, as they are contingent upon the movement in the underlying market, the gain is different from the coupon in a regular bond.

The change in the profile of issuers, mentioned at the beginning, is that earlier there were a few financial services-based non-banking financial companies (NBFCs) issuing this product in the wealth segment. While the financial services entities are still around to issue these, now many leading business groups have entered the fray as issuers. This makes a difference for you, not only in terms of a wider array of choice, but also on the credit profile. Though the pay-off is linked to the movements in another market (equity or G-sec), the instrument is ultimately a debenture carrying a credit risk. The NBFCs have a certain credit profile; as against that, there are quite a few issuers carrying top-notch credit ratings, belonging to leading business houses. That makes it a complete offering: good credit profile from the debenture perspective and multiple types of pay-off structures available, linked to various markets.

Here are some points that can give a sense of the composition or profile of the MLD market: there are more PP MLDs compared to non-PP, as investors prefer downside protection; the tenure usually ranges from 13 to 60 months, depending on the issuer’s funding requirements; the average tenure is a little less than three years; Nifty 50 is the preferred underlying index, but G-sec as a reference point is growing in popularity.

Given the advantages, it is worth having an allocation to MLDs in your portfolio. The only issue you may come across in this product is that it is not available in retail lot sizes. It is still in the HNI or mass affluent segment, and you need to have the investment ticket size as required by your wealth manager.

[“source=livemint”]

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Loknath Das

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