Structured Products: Equity Market Linked Debentures
Equity Market Linked Debentures (a form of structured products), provide investors an ability to participate in the equity markets with differentated return payoffs. This includes products that provide the same returns on the upside with no downside risk, or products that provide upside returns that are a multiple of what the market returns.
Wide Range of Risk-Reward Options
Depending on how the product has been structured, equity market linked debentures can provide investors a wide range of options in terms of the potential returns across a range of market conditions.
This includes products that provide the same returns on the upside with no downside risk, or products that provide multipled returns on the upside. Investors can invest in the structure that best reflects their market view or provides the required diversification/balancing impact on their larger portfolio.
How do Structured Products work?
Most structured products are structured as a Market-Linked Debenture, that is issued by an NBFC. This is essentially a form of borrowing for NBFC's that issue these market-linked debentures.
When an NBFC borrows against a normal bond, the NBFC pays the investor back a fixed coupon (or interest) and the return of capital at maturity. In the case of an equity market-linked debenture, the returns to the investor vary based on market-returns & the manner in which the product has been structured.
At the back-end the NBFC essentially uses a combination of futures & options, to create the return pay-off that is differs from that of traditional investment options.
What makes Structured Products Attractive
- Returns that are different from traditional investment options: By providing either equity-linked upsides with no downside risks, or multipled returns in specific market conditions, structured products provide investors an ability to participate in equity markets that best reflect their market-view or risk-profile. The same return-structures are not possible to create via traditional investment options.
The main risk with Structured Products
- Credit Risk of the Issuer: Since this is essentially a debenture that is issued by an NBFC, in case the issuing NBFC were to go bankrupt the investors capital will be at risk (any recoveries on the product will be dependent on how bankruptcy proceeding pan out).
Since this is a debenture issued by an NBFC, it is important to understand that there is no risk of the market-linked debenture not paying out the promised returns if it is solvent. This is because any change in payouts as compared to what was indicated at the time of issue, will be consisdered a credit-event and trigger potential bankruptcy proceedings.
Are structured products right for you?
As long as you are comfortable taking the inherent credit-risk of the issuing NBFC, structured products can provide some very attractive return-structures that can often be a lot more attractive than the returns offererd by traditional investment options. You can connect with one of our investment specialists to understand their relevance in your investment portfolio better.
Impact of taxation impact of FY24
Budget The new taxation of MLD's in the FY24 Budget (capital gains on MLDs to be taxed as per the tax slab) applies specifically to market-linked debentures that satisfy the following conditions
(a) any security which has an underlying principal component in the form of a debt security & where the returns are linked to the market returns on other underlying securities or indices
(b) the MLD needs to be listed
Accordingly, unlisted MLDs without principal protection will not be subject to the new taxation.
This is the current understanding of the primary issuers of MLD's based on their internal checks & CA confirmations. However, a different view taken by the IT department cannot be ruled out at this time, and investors should consider the risk of MMT taxation (instead of the 20% LT capital gains taxation without indexation benefits) prior to investing in these securities. Structured Product Calculators.
