Market-Linked Debentures (MLDs): How They Work, Why They’re Popular, and the Risks Investors Must Understand

What Is a Market-Linked Debenture (MLD)?

A Market-Linked Debenture (MLD) is a debt instrument issued by a company, typically an NBFC, where the return payable to investors is linked to the performance of a specified market index, such as the Nifty, Sensex or MCX Gold. Despite being “market-linked” in its payoff, an MLD remains a debenture — investors are lending money to the issuer, not investing in a fund or a managed portfolio.

What makes MLDs particularly attractive to investors is the range of asymmetric payoff structures they can offer. Depending on how they are structured, an MLD may allow investors to

• participate in the upside of an index with limited or no downside,
• earn enhanced or leveraged returns on upside, with normal downside risk
• earn fixed, bond-like returns with additional upside participation

These kinds of payoffs — especially when linked to volatile assets such as equities or gold — are difficult to replicate through traditional investment products, and can offer useful diversification and alternate return characteristics from a portfolio construction perspective,. This helps explain why MLDs have gained popularity over a period of time.

The term “market-linked”, however, often causes confusion. In an MLD, it refers only to how the final payoff is calculated, not to ongoing market exposure. The payoff structure is fully defined upfront and contractually promised at the time of issuance.

Unlike mutual funds, PMS or AIFs — where outcomes depend on a fund manager’s performance — an MLD’s return does not fluctuate day-to-day with the market. As long as the issuer remains solvent, the promised payoff must be honoured at maturity, irrespective of how the issuer internally manages or hedges the exposure. Any failure to do so constitutes a default under the debenture and can result in the issuer being taken to bankruptcy court.

If the Payoffs Look So Attractive, How Is This Even Possible?

When investors first see the payoff profiles offered by MLDs, a natural reaction is to wonder how such outcomes are even feasible. The key point to understand is that the complexity sits entirely with the issuer, not with the investor. While the investor only sees a simple, pre-defined payoff linked to an index, the issuer internally uses a combination of derivatives, hedging strategies and structured trades to manage the risk associated with delivering that payoff.

Importantly, investors do not need to understand — nor do they have visibility into — the exact strategies used by the issuer’s trading desk. These strategies can be complex and are designed to ensure that, across a range of market outcomes, the issuer is able to meet its contractual obligation. Whether those internal strategies perform well or poorly is irrelevant to the investor, as long as the issuer remains solvent and honours the terms of the debenture.

This distinction is crucial. In an MLD, the investor is not taking market risk in the traditional sense, nor is the return dependent on a fund manager’s skill. Instead, the investor is taking on the credit risk of the issuer, trusting that the issuer has the balance sheet strength, risk management capability and discipline required to deliver the promised payoff. This naturally leads to the most important risk consideration in MLDs — the creditworthiness of the issuer itself.

Key Risks to Understand in MLDs

While MLDs can offer attractive and differentiated payoff structures, investors should be mindful of the following three key risks, which ultimately determine outcomes:

• Credit Risk of the Issuer: As discussed earlier, an MLD is a debenture and therefore a credit exposure to the issuer. All promised payoffs — including so-called “principal protection” — are contingent on the issuer remaining solvent. If the issuer were to default for any reason, investors could face significant losses, potentially including a complete loss of capital, irrespective of how the underlying index has performed.
• Close-Ended Structure & Exit Timing Risk: MLDs are typically close-ended instruments with a fixed maturity. This means returns are determined by market conditions at a specific point in time. Unlike open-ended funds, investors do not have the flexibility to delay exit if markets are temporarily unfavourable at maturity, which can materially impact realised returns.
• Liquidity & Secondary Market Risk: Liquidity in MLDs is generally limited. While secondary market exits may be possible in some cases, they are often uncertain and can require selling at unfavourable prices, especially during periods of market stress. As a result, MLDs should usually be considered with a hold-to-maturity mindset.

IME Capital’s Perspective on MLDs

At IME Capital, we are long-term, fundamentals-driven investors, and we continue to believe that traditional asset classes — particularly diversified, open-ended equity investments — remain the most reliable vehicles for long-term wealth creation. Open-ended structures offer an important advantage: they allow investors to ride through periods of market volatility without being forced to exit at unfavourable times. Over longer horizons, diversified equity portfolios have historically provided a high degree of predictability in wealth creation on a risk-adjusted basis, with a relatively low probability of permanent capital loss.

That said, we do recognise that MLDs can offer genuinely attractive and differentiated payoff profiles that are difficult to achieve through traditional investment products. Well-structured MLDs allow investors to participate in volatile asset classes such as equities or gold in a controlled and pre-defined manner, offering asymmetric outcomes that can meaningfully improve risk–return characteristics. For investors who are comfortable with the associated risks, these structures can provide useful diversification, alternate return drivers, and tactical exposure—particularly in environments where markets are volatile or range-bound. When sized appropriately within a portfolio, MLDs can therefore add real value rather than merely cosmetic complexity.

That said, we do recognise that MLDs can serve a purpose for certain investors. The asymmetric payoff structures they offer, and the ability to participate in volatile asset classes such as equities or gold in a structured manner, can be appealing and may add value as a tactical or diversifying allocation within a broader portfolio. For investors who understand the risks involved and size their exposure appropriately, MLDs can be interesting instruments.

Ultimately, MLDs are neither substitutes for long-term equity investing nor risk-free return products. They should be approached as structured credit instruments, evaluated carefully, and used selectively. As with any investment, the key is not the attractiveness of the payoff alone, but a clear understanding of the risks being taken — and ensuring those risks align with the investor’s overall financial objectives and risk tolerance.