What are Market-Linked Debentures (MLDs)?
- What Are Market-Linked Debentures (MLDs)?
- Understanding How Market-Linked Debentures Work?
- Key Features of MLDs
- Types Of Market-Linked Debentures
- MLD Types Based on Principal Treatment
- Advantages And Risks of Investing in MLDs
- Conclusion
What Are Market-Linked Debentures (MLDs)?
Market-linked debentures (also MLDs) offer the benefits of both equity and debt instruments. They take advantage of the equity market while behaving as a debt instrument. Hence, the overall yield achievable is also more than that of traditional debt securities. It gives an edge over the plain vanilla bond and enhances its portfolio with this new variant of debentures.
Keep reading as we explain the MLD full form (Market-Linked Debentures), their key features, how they work, benefits, risks, and more.
Understanding How Market-Linked Debentures Work?
As the MLD full form states, the performance of these debentures is always linked to the market. It follows the footsteps of underlying indices, such as the Nifty 50, the 10-year government bond yield, gold, or similar assets. It is structured as a bond plus option program. Therefore, a significant amount is allocated to the bond, and the remainder to the derivatives contract (for market exposure).
If the market outperforms, the linked MLD also performs similarly. However, these MLDs have no fixed interest payments; a lump sum amount is released upon maturity. This amount includes the principal plus any additional yield that can be achieved on it.
For example, Mr. A bought a market-linked debenture note of ₹10 lakhs. This instrument was linked to the Nifty 50 index with a 3-year maturity period. The bond provides protection for the principal amount, while the derivative acts as an upside kicker. Therefore, if the Nifty 50 performs above the set limits, the benefit accrues to the investor. Likewise, if the Nifty 50 falls, Mr. A will still receive the principal amount. However, it depends on the type of MLD purchased.
Note: “The information, illustrations, and calculations provided in this blog are for general informational purposes only and should not be construed as investment advice or a recommendation.”
Key Features of MLDs
- No Regular Interest Payments - Unlike traditional debentures, MLDs do not issue regular interest payments. Depending on the index performance, the final amount is accumulated at the maturity date.
- Non-convertible Debentures - As they are NCDs, they cannot be converted into equity or stocks.
- Tenure: The maturity period of these debentures ranges between 13 to 60 months (1-5 years) in general.
- Tied to Market Index: With dynamic complexity, the MLDs are connected to the equity indices, shares, specific commodities, or even currency exchange rates.
- Tax Efficiency - All gains, irrespective of the holding period, are referred to as STCG (short-term capital gains) and taxed at individual slab rates.
- Regulatory Framework - SEBI guidelines regulate these market-linked debentures.
- Credit Agency Rated - With multiple ratings, such as AAA, AA+, AA, AA-, etc., investors can evaluate MLDs based on the level of risk involved.
Types Of Market-Linked Debentures
Going with the MLD full form, different types of market-linked debentures are linked to asset classes and principal treatment. It includes;
Key Categories of MLDs (Asset-class)
Equity-Linked Debentures
These MLDs are linked to the performance of a particular stock or a basket of such stocks. For example, based on the underlying stock's performance, the investor earns a yield accordingly.
Index-Linked Debentures
MLD full form stands for Market-Linked Debenture. It's tied to indices like Nifty 50 or Sensex, and your yield depends on how the index performs over time.
Commodity-Linked Debentures
Here, the yield is based on commodity prices, such as gold, silver, or oil. So, if gold prices fluctuate, investors earn a corresponding yield.
Currency-Linked Debentures
They are linked to foreign exchange rates, such as USD/INR or EUR/INR. Thus, the yield rates depend on the movement of the currency pair.
Hybrid MLDs
Here, hybrid market-linked debentures combine two or more asset classes (for example, equity and commodity). For example, the final payout may depend on the prices of Nifty and gold.
MLD Types Based on Principal Treatment
Based on principal protection and what the MLD full form (Market-Linked Debenture) implies, there are two types of market-linked debentures:
Principal-Protected MLDs
Here, the principal amount is safe and returned to the investor at maturity, regardless of market movement. The overall structure of MLD is designed to safeguard the principal investment.
Non-Principal Protected MLDs
In contrast to the first type, the principal is not guaranteed in this case. If the linked asset performs poorly, there is a risk to both yields and capital.
Advantages And Risks of Investing in MLDs
With the MLD full form and associated benefits, there are certain limitations of market-linked debentures as well. It includes;
| Pros | Cons |
|---|---|
| Equity upside with fixed-income safety | Poor market performance and volatility can bring in market and liquidity risk. |
| Downside capital protection in case the market underperforms. | Principal protection is not available for all MLD types. |
| Portfolio diversification into various asset-class exposure. | After the 2023 budget announcement, LTCG got eliminated. |
| Customization payoffs can be linked to equity, gold, interest rates, etc. | - |
| SEBI-regulated, with credit ratings provided | - |
Conclusion
Market-linked debentures are more than just debentures - a unique blend of debt security with market-linked yield. Thus, it makes them attractive for investors seeking potential upside with lower risk than direct equity. However, evaluating the issuer's creditworthiness, understanding the underlying benchmark, and considering the tax implications are essential before investing.
Disclaimer: The information, illustrations, and calculations provided in this blog are for general informational purposes only and should not be construed as investment advice or a recommendation to buy, sell, or hold any financial product. All examples and figures are purely illustrative and may be based on assumptions that can change over time. Actual results may vary and are subject to market risks and other factors. Readers are advised to independently verify all information and consult a qualified financial advisor before making any investment decisions. Neither the author nor ARSSBL shall be held responsible for any loss or liability arising from the use of this information.
