Market linked debentures (MLDs) denote a specific type of non-convertible debentures that do not offer fixed returns to the investors. Instead, their returns rely on the performance of a particular market index.
Debentures do not give you periodic payouts but you receive the entire corpus at maturity. To know in detail about what are market linked debentures, their advantages and associated risks, we suggest you continue reading.
How Do Market Linked Debentures Work?
Market-linked debentures are issued via a private placement route by various financial institutions and companies. They exhibit a maturity period ranging between 12-60 months.
Moreover, the returns from MLDs are based on ongoing movements in the market and are not fixed. You can notice the returns tied to an underlying index like equity benchmark, gold index, government yield and so on. Once the maturity period is over, you will be paid back your initial investment, along with the earned profit.
For instance, suppose a corporate entity provides an MLD with a 10% yearly return, conditional on the Nifty 50 index not decreasing by 20% or more over the investment’s duration. Contrarily, if the index rises by more than 20%, as an investor, you will get a 10% return plus surplus payments based on the margin over 20%.
Types of Market Linked Debentures
Two types of MLDs exist:
- Principal protected MLDs
- Non-principal protected MLDs
Principal Protected Market Linked Debentures
These instruments will repay your principal after maturity no matter how the market performs. This is how they provide you with downside security if in some cases the market movements experience a setback. Nonetheless, they also restrict the profit earnings in the case the market becomes more favourable throughout the tenure.
Non-principal Protected Market Linked Debentures
Investors with a higher risk appetite can go for these debentures as they do not offer any guarantee of repayment of principal. However, they offer much higher return potential, which can seem more reasonable to a specific class of investors.
Advantages of Investing in Market Linked Debentures
For an investor, some top benefits of investing in an MLD are as follows:
Provides a Hybrid Exposure to Asset Classes
Since MLDs consist of many carefully analysed finance modes, these investments are typically considered safe, as long as investors have confidence in the underlying assets of the debenture. Thus, you may use them to control associated investment risks.
Safeguard You Against Market Risks
By investing in principal-protected MLDs, you can guarantee the principal repayment at maturity, even if the underlying index performs poorly. It is a major advantage, especially when you are seeking downside risk management.
Offers Superior Returns
Compared to traditional fixed deposits, market linked debentures offer more returns while navigating various risk factors, unlike equities.
Diversifies Your Portfolio
To diversify holdings and guarantee a base return, you can consider allocating some assets to fixed-income securities.
Risks Associated With Investing in an MLD
Three prominent risks of a debenture-issuing company include:
Market Risk
It is the primary risk associated with market linked debentures. This can be a consistent threat as the underlying asset can experience price changes from market fluctuations.
Therefore, the value of an investment can decrease whenever the market faces a downturn. However, to safeguard against this, investors can restrict their losses by investing in principal-protected MLDs.
Credit Risk
Additionally, market-linked debentures are subject to credit risk, which can lead to instances where the issuer fails to repay the principal entirely or the returns. Whenever these scenarios take place, you may experience financial losses.
Like bonds, MLDs also showcase credit ratings. When you buy low-rated MLDs, the chances of default can be consequently high.
Moreover, the Deposit Insurance and Credit Guarantee Corporation (DICGC) does not back MLD investments, which in turn makes FDs a much more secure investment option available to all retail investors.
Liquidity Risk
Generally, market-linked debentures have low liquidity. This can be a concern for investors who might want to sell their possessions before maturity.
Taxation on Market Linked Debentures
In the 2023 budget, the taxation norms regarding market linked debentures underwent some changes. Earlier, the debenture owners owed a flat 10% tax on their earnings. However, now your returns are added to the total annual income and taxed as per the income tax slab rates. It means you may have to bear a potential tax rate of 30%, depending on your yearly income.
Final Word
If you compare with fixed deposits, market linked debentures hold the potential to offer higher returns. However, before investing it is essential to understand what are market linked debentures to avoid making impractical assumptions. After grasping the risks involved, you can allocate a certain percentage of investments in MLDs.
Frequently Asked Questions
If you want high post-tax returns, investing in market linked debentures can be a great choice. Additionally, they allow you to preserve your capital when you invest in the principal-protected MLDs.
MLDs pay you after maturity and do not offer regular payments like bonds.
Typically, you see tenures of MLDs ranging between 12 to 36 months.
