What are MLDs?

Structured Financial Products

For as long as the trade of commodities has existed, financial instruments in different forms have been in use to facilitate those trades. A simple exchange of invoices for funds (invoice discounting) was in use more than 4,000 years ago. Increasing trades across the vast seas increased the need for different types of instruments that made the flow of commodities and funds a bit more smoother than before.

The need for a tailor-made solution

The equity and bond markets had already been in existence for a long time and most people were aware of what to expect by investing in them. There was always a trade-off between risk and return which often made most people choose the safest set of options – to invest in fixed deposits and other traditional options.

The earliest and the first version of structured products were introduced in the UK and France in the late 1980s to early 90s period. The purpose was to provide access to equity-like returns but without any risk of losing capital. Since there were no such products, they ‘structured’ or tailored them.

What is an MLD?

MLD which means Market-linked Debenture. Essentially, it’s a hybrid debenture product categorized as a non-traditional investment class which is linked to another product or an index of products, the underlying benchmark. MLDs are known for their tax efficiency.

These instruments offer capital protection while their returns depend on how the underlying benchmark/asset performs.

We will give a simple example to explain how it works. Before that, it’s important to understand why having structured products in your portfolio is necessary.

MLDs: the X-factor for a portfolio’s growth:

Each investor’s portfolio is unique in its own way. So, it’s ideal if one focuses on growth keeping in mind their financial goals.

We now know that MLDs balance the portfolio and here’s how that is achieved:

It offers benchmark-linked returns that are predictable
As the conditions for the quantum of returns are determined when they are issued, returns become predictable.

It provides protection from market volatility
Though these instruments are market-linked, the conditions on the underlying are created in such a way that the probability of these events occurring is very less.

Tax efficiency at its best
MLDs are popular for the tax benefits they offer. Since the returns are paid as accumulative premiums, they would be taxed as capital gains at 10% if held for more than a year. The net effective tax rate for an LTCG flat taxation rate could be a maximum of only 14.25%.

Known for Tax Benefits

Just like equities are known for their high risk and high returns, MLDs are popular for the tax benefits they offer – they are taxed at 10% as LTCG if sold after holding for more than a year.

A rupee saved is indeed a rupee earned, but a rupee saved in the form of taxes is definitely ‘a lot more than a rupee’ earned!

These are the go-to products for the HNIs and ultra HNIs who are looking to diversify their portfolios at the least possible cost while also earning more than decent returns.

Because the product’s primary aim is not to enhance the returns and it is about a greater tax-return ratio, these products have an entry ticket size of around 10 lakhs.

Here’s how MLDs work

There are three components of an MLD: the debenture, the underlying asset/benchmark and the conditions on the underlying.

As we explained earlier, the returns depend on how the underlying asset/benchmark behaves. When we say ‘behaves’, we are referring to the absolute change or the rate of change in a pre-determined period.

Another important thing to note here is that, unlike regular debentures, these do not offer regular coupon payments. The return, or ‘premium’, would be paid at the end of maturity.

For example, an MLD with gold prices as the underlying benchmark.

The conditions to determine the returns could be something like this:
If the price of gold falls to Rs. 20,000 or lower, the return on MLD would be nil.
If the price of gold remains above Rs. 20,000, the return on MLD would be 10%.

The general practice in the market is that the MLD is sold off in a secondary market just before maturity.

Are MLDs the correct type of products for your portfolio?

Keep in mind that these are meant for tax efficiency and primarily for better returns. The entry ticket size is an effective way to filter out those investors who are not yet ready for products like MLDs. Given that these have a lock-in period of at least a year, do consider the need for the funds for the duration of the lock-in period and only then take the call.

Strike the chord of efficiency and high returns at once.

An all-season portfolio isn’t a candy store of financial products, nor should it have products that swing to the tune of changes in the broader market. Too much equity would mean too much volatility and an equal proportion of equity and debt might cancel out the gains. Being overweight on debt securities will be an obstacle to growth.

The answer to this issue can be a structured product like MLDs that can help strike a balance among risk, returns and volatility.

To understand more about how a real-world MLD opportunity works, check out the Opportunities page on our platform where you can find one such option product floated by a prominent business group.