Understanding Market Linked Debentures

Market-linked debentures (MLDs) have recently caught the fancy of investors. They seem to align well with many individuals’ portfolios in helping them achieve their financial milestones. However, for many, this may just seem like another complicated investment avenue. Here, we dive deep into MLDs to help you understand the nuances, which will help you make an informed decision.

What are MLDs?

MLDs are market-linked debentures where the returns are not fixed. They are determined by the movement in the underlying market index. They invest in various instruments, including but not limited to equity, government bonds, bonds, gold index etc. As mentioned in the scheme investment details, the underlying instruments are determined based on the mandate. The tenure of the funds could range between 1 – 5 years. The pay-out happens at maturity in these instruments, the returns are accrued, and principal and accrued returns are paid out upon maturity.

Types of MLDs:

The two main types of MLDs are:

1. Principal protected:
   These MLDs have a capital protection feature. Here, the capital or principal amount is guaranteed, despite extreme volatility in the market. It is an effective downside protection investment. If the market movement is downward, you may get zero returns, but you would still get the capital amount. If the market movement is favourable, you are likely to get commensurate earnings.
   
   
2. Non–principal protected:
   The risk is significantly higher as the principal is not protected. While the potential is relatively high, the downside probability is also high. 

There are other variants in the MLD, like those listed for public trading; non-listed are those which are not traded in the market. Secured where the MLDs are backed by high-quality bonds, securities with shallow default risk. Unsecured MLDs are not backed by high-quality securities and often have higher default risk.

Features of MLDs:

Below are some of the common features among MLDs:

• Minimum investment amount in MLD is Rs. 10 lakh – Rs. 25 Lakhs, regulated by SEBI
• They are generally issued with a tenure ranging between 1 – 5 years
• Credit rating agencies rate MLDs. The default risk is dependent on the rating of the instrument. Typically, AAA and AA+ are considered high-quality instruments with relatively lower risk.
• MLDs do not pay regular income like many of the fixed income securities, the payment is made only upon maturity, and both principal and accumulated returns are paid out at maturity.
• There are listed / unlisted MLDs and secured / unsecured MLDs. Their liquidity is managed for unlisted instruments as the issuers sometimes buy back the MLDs.
• MLDs are aimed at a niche clientele. They are highly customised to cater to the specific needs of the investors that they cater to.

Suitability Analysis:

MLDs are open to a vast audience. However, they are just like other debt instruments with a slightly higher risk profile. They also have the potential to generate higher returns. Listed MLDs are taxable at only 10% if sold in the market after a holding period of 1 year. From a taxability perspective, MLDs remain extremely attractive as they do not have a  gestation period of 3 years to be categorised as a long-term capital asset as in the case of other debt mutual funds. They can provide better post-tax returns as compared to non-market-linked debt instruments. 

In a nutshell

MLDs are a departure from your conventional debt instruments. You step into an arena which is slightly riskier asset, nonetheless offers better returns. However, they are a relatively complex investment vehicle compared to your familiar debt instruments. Always research thoroughly, understands the underlying risk and invest in avenues which complement your risk appetite and your existing portfolio. You can seek the assistance of financial experts at TATA Capital Wealth to help you make the right decision for achieving your financial goals in a stress-free manner.