What are Market Linked Debentures
Market-linked debentures, popularly called MLDs, are debt investment instruments. The returns on the investment are dependent on the performance of a specific market index rather than being fixed.
These structured instruments typically only have one pay-out at maturity and no other monthly payments. This is because the returns earned from the MLDs are directly linked to the returns generated by their underlying securities.
These underlying securities could be any Nifty, Sensex, or any other instruments.
To gain indirect access to these markets and greater returns, MLDs are nearly like placing a competitive bet on the stock market, shares, or government securities.
How Do Market Linked Debentures (MLDs) Make Returns
There is no intermediate income to be gained during the holding period of an MLD. Thus, the gain is computed at maturity depending on how the underlying security has changed.
It is to be noted that, unlike other Debi instruments, the returns of the MLDs are subjective.
Consider, for example, the MLDs are issued to investors at a 10% rate of return per annum. The catch here is that this MLD is linked to the performance of the Nifty infra index fund.
If the refunds generated by the infrastructure industry are under the permissible limits, as stated by the MLDs during its issue, the returns will be rewarded to its investors.
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Types of MLDs
There are majorly 2 types of MLDs
- Principal protected MLDs
- Non-principal protected MLDs
In the case of principal-protected MLDs, the prime investment of the investor will be returned in toto of the underlying security under performs.
On the other hand, in the case of non-principal protected MLDs, there is a substantial probability that even the initial investment of the investor can be reduced. In this case, the investors’ investment amount is at stake too.
It is safe to assume that principal-protected MLDs are less risky than the latter.
Factors that Determine the Returns on MLDs
The underlying index or asset that the investor’s pay-out is linked to is completely under the investors’ control.
The 10-year government bond yield, the nifty, the bank nifty, gold, or another underlying index or asset are some examples of the underlying securities used.
The objective is to choose an asset that is actively traded but challenging to manipulate.
Returns on MLDs with Credit Risk
With investment in MLDs, there will always be a chance that the issuing authority may not make its principal or interest payments, putting the investors in danger. When investing, one should exercise caution and consider the credit rating given to the MLDs of various businesses.
Things to Note
Retail investors with a poor risk appetite should avoid these complicated instruments. This is because they need a minimum commitment of 25 lakhs or more.
High Net Worth Individuals can invest in these structured products if they wish to diversify their investment portfolio, or, if they want to get higher returns while being willing to incur risks.
Conclusion
When compared to some fixed-income products, MLDs have higher rates of return and allow you to share in the gains of the equity market index.
However, these are intricate devices, so you should carefully consider them before investing. One can consider investing in these modern MLDs if they are aware of the complexity and have a high tolerance for risk.
Also Read: 5 Reasons Why Bonds Are Better Investment Than Debentures
