An Introduction to Market Linked Debentures

Debt investments are known for protecting capital, while equity investments aim to grow it. However, what if there was an investment option that could offer both capital protection and potential growth? Enter Market-Linked Debentures (MLD), also known as Structured Bonds.

Market-Linked Debentures (MLD) are a hybrid investment option issued in the form of a bond, where the returns or interest received is dependent on the performance of the Market. A simple example is – if the Market goes up, the coupon received increases; and if the Market goes down, the coupon received decreases.

Though MLDs may appear a bit complex at first glance, when broken down, they are quite easy to understand.

Why have I never heard of MLDs and why should I consider them for my portfolio?

MLDs are actually very popular globally, having gained prominence in the last couple of decades. These products have over USD 2 Trillion worth of Assets Under Management (AuM) as of 2019. In comparison, the global Mutual Fund AUM is USD 45 Trillion, Indian Mutual Fund AUM is USD 541 Bn (as of Jun’23) and Indian investment in Fixed Deposits in USD 1256 Bn (as of Mar’23).
(Source: Structured Retail Products, Investment Company Institute, AMFI, RBI)

Traditionally, only institutions and ultra-high-net-worth individuals have invested in MLDs due to their complexity, limited access, and higher ticket sizes.

But the rise of technology has now made these instruments accessible to all investors due to smaller ticket sizes and more consumer-friendly offerings. MLDs have the potential to significantly improve your portfolio’s risk-adjusted returns, making it a perfect fit in your portfolio.

Types of MLDs

There are two main types of MLDs:

1. Principal Protected
2. Non-Principal Protected

As the name suggests, Principal Protected MLDs are products where the invested principal is 100% protected. i.e. there is no downside risk. Which means however negative the Market goes against you, at the end of the maturity period, you will always get back your entire Principal.

Non-Principal Protected MLDs do not offer this protection and therefore are riskier.

MLD Terminology

Some terms that you must know when investing in MLDs:

• Maturity – Maturity refers to the tenor of the investments. Usually, MLDs have a tenor ranging from 1 year to 5 years though in rare cases, it can be much longer too.
• Underlying Asset – This refers to the Market Benchmark that is used to determine the returns of the MLD. Some examples of underlying are Nifty 50 Index, Nifty 100 Index, 10-Year G-Sec Index, etc.
• Principal Protection – This refers to the extent of protection to the principal. A 100% Principal Protected MLD means that whatever may be the return on the underlying, there will be zero loss on the principal amount.
• Payoff – The payoff refers to the return on the MLD which is determined based on the underlying asset. The payoff is also referred to as the Coupon or simply as Returns.
  There can be a Floor (Minimum returns) and a Cap (Maximum returns) on the returns in MLDs
• Liquidity – This refers to the ability to liquidate the MLD and convert it into cash before its Maturity

MLD Returns

Let us now take the example of a simple MLD and explain how returns are generated in different scenarios:

• Maturity – 2 Years
• Underlying Asset – Nifty 50 Index Returns
• Principal Protection – 100% Principal Protected
• Payoff – Linked to Nifty 50 Index Returns with a Floor – Minimum 14% Returns and Cap – Maximum 30% Returns
• Liquidity – Anytime

How MLDs work

Let us now take the example of a simple MLD and explain how returns are generated in different scenarios:
Let’s see how Principal Protected MLDs work through this infographic.

Now that we have understood how an MLD works, let’s see why an MLD should be a part of your portfolio.

Why should I invest in MLDs?

MLDs have the potential to solve many investing hurdles.

1. 1. Want to book profits in Equities without regret?
      The decision of booking profits at the correct time is a very tricky one. Selling your stocks and seeing the markets go up can be agonizing, and on the flipside, not selling and seeing the market crash can be equally painful.MLDs are amazing in solving this problem. Principal Protected MLDs allow you to remain invested in the Market without risking your capital and profits, so you get only the upside without the downside.

1. 1. Never Invested in Equities?
      For someone who has never invested in the Stock Market because they are not comfortable with the volatility, MLDs can be a good starting point. Many MLDs offer Principal Protection and some also offer a minimum return that is often comparable to fixed deposits. So once can invest in the stock market with the comfort of having principal protection and some minimum fixed returns.

1. 1. Want to reduce the risk of your portfolio?
      MLDs have the potential to reduce the risk of the overall portfolio. Taking the same parameters of the previous example
      • Maturity – 2 Years
      • Underlying Asset – Nifty 50 Index Returns
      • Principal Protection – 100% Principal Protected
      • Payoff – Linked to Nifty 50 Index Returns
      • Floor Minimum 14% and Cap Maximum 30%
      • Liquidity – Anytime

      and creating two portfolios,

      • Portfolio A: 100% invested in Nifty 50 Index
      • Portfolio B: 50% invested in Nifty 50 Index + 50% invested in the above Nifty 50 based MLD

Let’s see how both these portfolios perform in different scenarios. Even in a severe loss in the Nifty 50 Index, as highlighted in scenario 2, the loss (drawdown) in Portfolio B is significantly lower than Portfolio A.

Where do MLDs lie in the Risk Reward Matrix?

MLDs have the potential to increase the returns of your portfolio without taking significantly higher risk. MLDs provide the best of both worlds – Debt & Equity.

Are MLDs risky? What are the risks that I should be aware of while investing?

Like all financial instruments MLDs also have their share of risks. There are 3 main risks that investors should be aware about while investing in MLDs:

What will be the Taxation of MLDs in India?

Any gains arising due to sale, maturity or redemption will be treated as Short Term capital gains, irrespective of the holding period and listing status, and hence will be taxed as per the investors Marginal Tax Rate. This taxation places MLDs on an equal footing with other Debt Instruments, like Corporate Bonds, Debt Mutual Funds and Fixed Deposits.

InCred Money’s MLD Offering

At InCred Money, we are aiming to simplify investments and provide access to opportunities that help improve your portfolio with superior risk adjusted returns, and the introduction of MLDs as an investment product is a significant step in this direction.

Previously, due to high ticket sizes, MLDs were only accessible to institutions and high-net-worth individuals (HNIs), enabling them to enhance the efficiency of their portfolios.

The MLDs curated on the InCred Money platform are issued by Non-Banking Financial Companies (NBFCs) with strong financials, ensuring that the Credit Risk is minimized. The offered MLDs will also be listed on the stock exchanges.

We will showcase only those issues that are Principal Protected, Secured and have an Investment Grade Credit rating.

We also offer various options to cater to different types of investors and their unique needs, ranging from conservative to aggressive strategies. To enhance accessibility, we have made MLDs available at ticket sizes as low as Rs. 1,00,000.

However, what sets our offering apart is the ‘Anytime Liquidity’ feature, a rare offering in the MLD market. We understand the value of liquidity and strive to provide our investors with flexibility and convenience when managing their investments.

Check out all our live issues here.